By Stuart Saft, Partner, Holland & Knight
On August 29, 2012 the Securities and Exchange Commission (the "SEC") issued proposed changes to its Regulations implementing changes in the federal Securities laws, that were contained in the Jumpstart Our Business Startups Act (the "JOBS Act"), which can be used by real estate syndications and condominium sponsors with rental pools to permit the nationwide advertising and sale without the registration of the offerings with the SEC.
As described below, real estate syndicators have been able to use Regulation D to make offerings to an unlimited number of accredited investors and up to 35 non-accredited investors, but the investors had to have a pre-existing relationship with the syndicator and could not do general advertising and this exemption from registration was not available to condominium sponsors of units that were to be part of a rental pool. The limitation on its use for condominium sales was caused by the SEC holding that a condominium unit could be treated as a security if it was offered in conjunction with any of the following factors: (i) emphasis on economic benefits to the purchaser to be derived from the managerial efforts of the promoter, or a third party designated or arranged for by the promoter, from rental of the units; (ii) the offering of participation in a rental pool; or (iii) the offering of a rental or similar arrangement whereby the owner must hold his unit available for rental for any part of the year, must use an exclusive rental agent or is otherwise materially restricted in his occupancy or rental of his unit.
In 2002, this was modified by the SEC to permit the mention of the existence of a rental program in sales and promotional materials by using a statement such as “ownership may include the opportunity to place your unit in a rental management arrangement” and can enter into a rental management agreement at the time the purchase agreement is signed but prior to closing, provided the agreement is contingent upon the closing of the sale. However, there was still an impediment to selling more than just the condominium units and was particularly troubling for hotel condo sponsors, where the purchasers were purchasing their units for investment.
The alternative for both real estate syndicators and condominium sponsors was to treat the offerings as securities and go through the time and expense of a filing with the SEC and the subsequent reporting requirements for public companies.
However, the JOBS Act provided a way to avoid these marketing limitations because it permitted syndicators and sponsors to acknowledge that the interests are securities, but would not need to register the offering with the SEC because of the availability of an exemption that, prior to the JOBS Act, was too narrow to permit any relief from filing.
Rule 506 of Regulation D is a long-standing and much-used exemption from the registration requirements of the Securities Act of 1933. Through this exemption, issuers can sell unregistered securities to an unlimited number of accredited investors and a limited number of non-accredited investors. Title II of the JOBS Act reversed that limitation and permitted the general solicitation and advertisement of a Rule 506 offering, as long as all ultimate purchasers are accredited investors. Accredited investors have to have a net worth in excess of $1 million or net income above $200,000 a year for an individual or $300,000 a year for a married couple for the previous two years. The proposed amendment to Rule 506 would provide that the prohibition against general solicitation and general advertising contained in Rule 502(c) of Regulation D would not apply to offers and sales of securities made pursuant to Rule 506, provided that all purchasers of the securities were accredited investors. The proposed amendment to Rule 506 would also require that, in Rule 506 offerings that use general solicitation or general advertising, the issuer take reasonable steps to verify that purchasers of the securities are accredited investors.
By removing the ban on general solicitations, sponsors and syndicators do not have to rely solely on existing relationships for funding. A wider audience of investors can be reached via the Internet, seminars and other venues. Additionally, sponsors, syndicators and placement agents can also use Rule 506 to advertise securities through a diverse range of mediums.
Moreover, under Title II of the JOBS Act, individuals who conduct Rule 506 offerings via the Internet or through other media are not required to register as brokers or dealers. Offerings may employ general solicitation and general advertising to market the unregistered securities. However, although the JOBS Act eliminates the need to register these securities with the SEC, sponsors and syndicators would still need to comply with the various states' Blue Sky Laws.