Earlier this year, President Obama signed into law the Jumpstart Our Business Startups (JOBS) Act, a provision of which directed the SEC to relax regulations regarding general solicitation of private securities offerings. On Wednesday, August 29th, the SEC did just that, proposing to amend Rule 506 of Regulation D to allow general solicitation of private securities offerings, provided that all purchasers are accredited investors or investors whom the issuer reasonably believes are accredited investors.
The goal of the original legislation was to ease regulations faced by entrepreneurs seeking financing. Without the rule change, startups face limited options for funding. Their first option is a private placement in which the offering is made only to a limited number of accredited investors generally with whom the issuer already has a preexisting relationship. Section 502 of Regulation D currently prohibits marketing these investments to the public. Startups’ other option is a public offering (IPO). This option, however, requires registration with the SEC, which is often cost-prohibitive for many startups.
The rule change permits the general solicitation of private offerings provided that:
- the issuer takes reasonable steps to verify purchasers are accredited investors;
- all purchasers are accredited investors or the issuer reasonably believes all purchasers are accredited investors; and
- all other conditions of Rules 501, 502(a), and 502(d) of Regulation D are satisfied.
Section 501 of Regulation D provides the definition of accredited investor, which includes eight categories of investors ranging from institutional investors to individuals with incomes greater than $200,000 per year or assets in excess of $1 million. The proposal, however, does not define “reasonable steps,” instead providing a list of factors to be considered in determining reasonableness, including the nature of the purchaser, the amount of information the issuer has about the purchaser, and the nature of the offering.
This murkiness regarding what constitutes “reasonable steps” means that the proposal “is not necessarily great news to issuers looking to raise funds from a broader audience of investors,” says UC Berkeley School of Law Professor Robert Bartlett. This ambiguity is complicated by the different accreditation standards faced by different types of accredited investors. For instance, the requirements for a corporation to qualify as an accredited investor are different from those of a private foundation or an individual. Essentially, this proposal requires the issuer “to modulate the protocol for each type of investor,” says Bartlett.
Professor Bartlett believes there are two likely outcomes given this ambiguity if the proposal is adopted. First, investors and issuers may ignore this new option, instead electing to avoid the uncertainty risk associated with general solicitation. Alternatively, issuers may use this new general solicitation option, but “be quite discriminatory in how they sell to new, non-institutional investors,” says Bartlett. “The one exception might be if a third-party (such as a broker dealer who has prescreened investors)” can perform the screening process and assure the issuer that potential investors comply with their respective standard, says Bartlett.
This Friday, September 7, Professor Bartlett will give a presentation to the SEC’s Advisory Committee on Small and Emerging Companies on the impact of disclosure rules on small public companies. This meeting is open to the public and can be accessed via phone. Details on the meeting are available here.