Critics Lamblaste SEC’s Proposals for General Advertising Rules
Investor associations and members of Congress assail proposed new rules by the SEC to regulation general advertising for private placement of equities, charging the new rules place undue burdens on raising capital for entrepreneurs. The SEC proposed amendments that would, among other things, require “real time” filing of ads for private placement and Form D filings 15 days before an issuer can place an ad.
The proposed rules are “setting new policy by bureaucrats in an area where the policy should be set by legislators,” lamented Dan Rosen, board member of the Angel Capital Association. The chairs of the House Subcommittee on Oversight and Investigations and the Subcommittee on Capital Markets and Government Sponsored Entities were more direct: certain provisions “effectively violates Title II of the JOBS Act.”
Lifting the Ban on General Solicitations
On July 10, 2013, the Securities and Exchange Commissions released rules mandated by Title II of the Jumpstart Our Businesses Startups Act that would lift the ban on advertising private placements of equity to accredited investors under Section 506, Regulation D. The final rule makes changes to Rule 506 to permit issuers to use general solicitation and general advertising to offer their securities provided that:
- The issuer takes reasonable steps to verify that the investors are accredited investors.
- All purchasers of the securities fall within one of the categories of persons who are accredited investors under an existing rule (Rule 501 of Regulation D) or the issuer reasonably believes that the investors fall within one of the categories at the time of the sale of the securities.
- Under existing Rule 501, a person qualifies as an accredited investor if he or she has either:
- An individual net worth or joint net worth with a spouse that exceeds $1 million at the time of the purchase, excluding the value (and any related indebtedness) of a primary residence.
- An individual annual income that exceeded $200,000 in each of the two most recent years or a joint annual income with a spouse exceeding $300,000 for those years, and a reasonable expectation of the same income level in the current year.
However, the SEC has proposed additional requirements and conditions on issues that would, if adopted, create additional compliance burdens, which would include:
- A Form D filing would be required before any general solicitation happens (rather than after the sale of securities as is the current requirement).
- Updated “closing” Form D’s would be required for all 506 offerings once they terminate.
- Require certain legends and other disclosures in offerings that use general solicitation (not a huge deal, because much of this is typically covered already in offering materials).
- Require (at least for the next two years) that written general solicitation materials be filed with the SEC.
Criticism of the Proposed New Rules
Critics attacked the new proposals. In a post on the Angel Capital Association website, board member Dan Rosen summarized ACA members’ concern about the rules: “Simply put, the proposed SEC ruling is (a) trying to fix a problem that doesn’t exist; (b) will increase risk in our early-stage deals by adding a dimension of regulatory risk that isn’t there now; (c) will increase the cost and time for getting deals done; and (d) violates the Congressional intent of the JOBS Act, which recognized that using angel investment to create more jobs in startup companies was good for the U.S.”
Final rules ending the ban on general solicitation for companies seeking investment from accredited investors eliminates the ability of angels to self-certify their status, and will result in many angels refusing to participate in this type of investing, according to the Angel Capital Association (ACA).“With thousands fewer angels participating in this market, startups will have far less access to capital, the millions of jobs they create each year will disappear, and the economy will suffer,” said Marianne Hudson, executive director of ACA. “This is the exact opposite of Congress’ intent in its near-unanimous passage of the JOBS Act.”
Can You Use Twitter?
Will entrepreneurs be able to use Twitter to seek investors for startups under the proposed amendments? “Well, not quite,” Joe Wallin, Founder and Editor, wrote in Startup Law Blog. “The SEC’s new rules on generally solicited offerings are going to require inclusion of lengthy legends in any written communication that constitutes a general solicitation or general advertising, ‘in a prominent manner.’”
The legends require disclosures such as the securities may be sold to accredited investors, that they are offered in reliance on exemption from the registration requirements of the Securities Act, that the SEC has not passed on the merits of the offerings, and that investing involves risks. “These legends exceed 140 characters,” Wallin wryly noted.
Under the new rule, issuers must take reasonable steps to verify that their investors are accredited, steps that may not be readily apparent to the lay businessman. “Small business owners and entrepreneurs must have a clear understanding of the steps the SEC expects them to take in verifying investor status, and would be well advised to seek professional advice,” states Mike Scott, President of PPM Fast.
Rep. Patrick McHenry (R-NC), chairman of the House Subcommittee on Oversight and Investigations, and Rep. Scott Garrett (R-NJ), chairman of the House Financial Services Subcommittee on Capital Markets lambasted the new amendments, claiming the new rules run contrary to the intent of the JOBS Act. They further demanded in a joint letter on July 22, 2013 that the SEC provide some backup that justifies the new proposals. justification for certain rules that the chairs believed were contrary to the intent of the JOBS Act. “Although we support the Commission’s final rule implementing the lifting of the ban on general solicitation, the addition of the Proposed Rules, which require Regulation D 506(c) issuers to comply with new disclosure requirements, surmount additional regulatory hurdles and shoulder increased liabilities, create significant concerns,” Representatives McHenry and Garrett wrote. “Proposed Rule 503 requires a fifteen day waiting period, after filing Form D, before allowing advertisements – this restriction appears to violate the law by imposing a fifteen day ban on general solicitation. Title II of the JOBS Act lifted the ban on general solicitation for Regulation D 506 offerings to accredited investors. As a result, the Form D pre-filing requirement effectively violates Title II of the JOBS Act.”
The Representatives also criticized a proposed Rule 510T that requires issuers must provide the Commission with all advertisements by the date of first use, and the requirement for standard or “canned” disclosures attached to advertisements under proposed Rule 509. “Such disclosures, along with increased disclosure requirements under Form D, constitute the Commission’s unauthorized effort to impose a disclosure regime onto private issuers that is clearly outside the intent of Congress.”
The SEC, nevertheless, obtained some kudos. The Crowdfund Professionals Association lauded the SEC’s release of the general solicitation rules. “We applaud the commission’s progress on Title II of the JOBS Act,” says Maurice Lopes, Governing Board Member for the Crowdfunding Professional Association and Founder of EarlyShares, “We look forward to working closely with them through the implementation of Title III.”
The SEC is seeking comments on the new proposals no later than September 23, 2013.
Article by A. Brian Dengler, member, CIFRA.