BY:Daniel M. Wasser
On September 23, 2013, an oxymoron became real: the publicizing of private offerings. Although film and theater producers can raise money through public offerings, as a practical matter they are too time-consuming and expensive to be undertaken unless very large sums are involved. The far more common approach in theater and independent film is to raise funds through private offerings. As the name implies, private offerings involve the solicitation of closed circles of investors reached through personal relationships rather than broad-based marketing efforts – at least until now.
A radical transformation of private offerings began in 2012 when Congress passed the JOBS Act and directed the SEC to develop rules to allow general advertising and solicitation in connection with private offerings. The SEC has now issued final rules that became effective on September 23, 2013. As a result of those rules, within the context of a private offering, film and theater producers now have the option to undertake broad-based marketing efforts and pursue investments from unlimited numbers of people as long as funds are accepted only from “accredited investors.”
Broadly defined, an “accredited investor” is a person with at least a $1 million dollar net worth exclusive of primary residence or a person who has earned at least $200,000 a year for the past two years (or $300,000 together with spouse) and who has a reasonable expectation of reaching the same income threshold in the current year. An accredited investor also can be a principal of the issuer, an entity whose owners are all accredited investors or an entity not formed to invest in a particular offering with over $5,000,000 of assets.
A New Era
Under the new rules, a theater producer can put an advertisement in Playbill announcing the producer’s latest project and need for investors. A film producer can end a trailer with a solicitation for investors. Most significantly, the new rules are expected to unleash the power of the internet and enable producers to develop pools of investors via social networking on Facebook, Twitter, LinkedIn and blogs.
The fact that marketing efforts reach mostly unaccredited investors is not problematic as long as funds are received only from persons the producer has confirmed through reasonable measures to be accredited investors. Just what measures will be deemed reasonable are not dictated by the new rules. It seems clear that check-the-box self-certification will not be adequate in most instances unless the producer has other reasons to believe in its accuracy – e.g., the investor has $500,000 to invest or is a public company executive whose income is reported in public filings. The SEC has indicated its comfort with the following approaches: verifying income through copies of tax returns or W-2’s for the past two years with a representation of a satisfactory level of anticipated income for the current year; verifying net worth through copies of bank statements and a credit report dated within three months together with a representation that all liabilities necessary to make a determination of net worth have been disclosed; or obtaining written confirmation of net worth or income from an accountant, attorney, registered broker-dealer or investment advisor who certifies having taken reasonable steps to verify the investor’s accredited status within the past three months.
Accompanying the new rules on general solicitation and advertising are new rules barring so-called “bad actors” from serving as officers, directors, 20% owners, or promoters of Rule 506 offerings (i.e., private offerings generally limited to accredited investors). In this instance, the term “bad actor” has nothing to do with acting talent. Rather, it reflects a concern that advertising will bring out the unsavory elements of the securities industry, such as high-pressure boiler room operators and spammers, who will induce people – particularly the elderly – to invest in unsuitable or fraudulent schemes. Accordingly, as of September 23, 2013, persons with criminal records or who have been subject to certain SEC proceedings or sanctions within specified periods are barred from holding positions of influence in companies making Rule 506 offerings.
Some Words of Caution
Producers who commenced an offering under the old rules prior to September 23, 2013 and now seek to take advantage of the new rules may do so, resulting in a hybrid offering. Transitional rules will need to be strictly observed.
The new rules do not authorize crowdfunding. The JOBS Act calls for implementation of an equity-based crowdfunding model (as opposed to the Kickstarter type of donation-based crowdfunding model), but this will not become a reality until the SEC develops implementing regulations.
Although the SEC loosened the rules on general solicitation and advertising, it did not relax the requirement that investors be provided with the information necessary to make informed decisions and that there be no material misstatements or omissions in such information. Thus, an email blast touting a “can’t miss” investment is not the sort of advertising authorized by the new rules. Similarly, advertising is not intended as a substitute for full and fair disclosure; rather, it is only a means to reach potential investors who would then be provided with customary offering papers.
The day the SEC issued final rules authorizing advertising in compliance with Congress’ directive under the JOBS Act, the SEC also issued for public comment a number of proposed rules that would, among other things, increase the filing requirements associated with Rule 506 private offerings and impose substantial penalties for compliance failures. Whether the proposed additional rules will gain traction is uncertain, but their issuance, together with the bad actor rule, suggest strongly that regulators are likely to step up oversight of Rule 506 private offerings, particularly those involving general solicitation and advertising.
Producers who consistently rely on a circle of loyal investors may find the new rules of limited interest, but most producers and persons hoping to become film or theater producers are likely to view them as exciting opportunities. Because passage of the new rules has not necessarily been embraced by the SEC and state securities regulators, it will be particularly important for producers who utilize advertising when fundraising to insure that all of the new rules are observed.
The information in this article is of a general nature and should not be relied upon as legal advice.
September 23, 2013
DANIEL M. WASSER is a partner of Franklin, Weinrib, Rudell & Vassallo, P.C. Before joining the firm, Dan specialized in corporate and securities law. Since then, he has accumulated over 25 years of entertainment law experience, with particular emphasis on theater law. Dan received an A.B. degree from Brown University, where he was a member of Phi Beta Kappa and his law degree from New York University.