Although the SEC recently finalized rules that will remove the ban on general solicitation and advertising for certain private offerings under Rule 506 of Regulation D, it does not mean that issuers will have free reign and complete discretion over their use of advertisements. That is, issuers looking to locate potential investors through advertising after the new rules become effective in September may still be subject to other laws that will restrict the manner in which they advertise or solicit investments.
For example as Keith Bishop over at the California Corporate & Securities Law Blog points out in a recent post that certain other state laws may be implicated with these types of advertisements. According to the post, in California, Rule 260.302 of the California Code of Regulations states, in part, that:
An advertisement should not contain any statement or inference that an investment in the security is safe, or that continuation of earnings or dividends is assured, or that failure, loss, or default is impossible or unlikely.”
Thus, it is possible that states could use advertising laws and regulations to regulate, to some extent, private offerings under the new Rule 506. However, the question remains, as to how far these types of state laws and regulations can go? The answer to this question is likely a complex legal question involving, at a minimum, federal preemption and First Amendment issues.
With the enactment of NSMIA years ago, Section 18 of the Securities Act provides that states are generally not permitted to directly or indirectly regulate federal “covered securities,” which includes securities exempt from registration pursuant to Rule 506. Additionally, as we have learned in the recent U.S. Supreme Court decision in Citizens United (which I have discussed in prior posts here and here in the context of campaign contribution disclosure requirements), corporations have rights with respect to the freedom of speech under the First Amendment similar to those of individuals. Thus state regulation of the content of a private placement advertisement could potentially result in a constitutional violation unless such advertisements fall within the definition of “commercial speech” which is not protected to the same extent as other forms of speech. However, despite these restrictions, there may be viable methods that states could employ to indirectly regulate private offerings that employ advertising or general solicitation, the California example above likely being one of them. If states choose to go down this path, they will need to strike a fine balance so as to not over-step their bounds, which could result in these types of laws and regulations, and the application of such laws and regulations, being challenged as unconstitutional.
Although I believe that the changes to Rule 506 removing the ban on general solicitation and advertising are a step in the right direction that will greatly help capital rising for companies, issuers need to be aware of any other laws or regulations that could impact the manner in which they advertise or solicit investors under Rule 506. Issuers taking advantage of the new rules permitting advertising in connection with private placements need to keep in mind that (1) the general anti-fraud statutes of the federal securities law will still apply to all exempt securities and transactions, including those involving the newly revised Rule 506, and (2) other state laws may indirectly affect private offerings using general solicitation and advertising. Like with any new law or regulation, compliance may be an issue early on since no one will have a feel as to how the SEC will be interpreting and enforcing these rules. Therefore, early adopters should tread carefully.