A review of some of the approximately 300 comment letters the SEC has received relating to its latest round of Regulation D proposals is a showcase for the various types of companies that have already sprung up in the hopes of profiting from the general solicitation and (eventually) crowdfunding rules.
As we previously noted, the SEC’s adoption of new Rule 506(c), which for the first time in the history of the securities laws allows for the use of (mostly) unrestricted advertising in connection with the sale of unregistered securities, triggered a number of additional proposals by the SEC, including: 1) requiring that a pre-offering Form D be filed at least 15 days in advance of the use of general solicitation materials; 2) requiring issuers to file with the SEC copies of any general solicitation materials no later than the date the materials were first used; and 3) amending the content of Form D, including an additional item (Item 22) that requires issuers to specify the method they used to verify the accredited investor status of their investors.
Besides Congressmen (who claim that some of the proposals violate the JOBS Act) and lawyers, business interests are generally the only commenters to present any detailed analysis of or comments in response to the proposed rules. While the analysis presented is perceptive in some cases, it also tends to directly align with the business interests of the commenters. For example:
CMPLY, Inc., “provides solutions for measurement, management and compliance in social media” through the use of systems of “layered notices” that let users select certain form disclaimers for insertion into their social media messages by clicking on a badge or icon. CMPLY can also monitor social media channels and raise alerts when certain disclosures are omitted. Not surprisingly, in the words of James Graham, the company’s COO & CFO “we wholeheartedly support the Commission’s desire to protect investors with this proposal.” It’s easy to see how CMPLY would be in a strong position to benefit from an SEC requirement that all general solicitation materials include certain standard legends and disclaimers.
AngelList describes itself as “a web-based platform that, among other things, helps accredited investors connect with startups in need of financing.” AngelList is critical of the proposed rules, and provides a good, coherent summary of its estimation of the problems the new rules would create:
- The requirement to file a Form D 15 days prior to the financing, or at the close of financing even if a financing doesn’t close, is meaningless in our world. Startups are always financing.
- The requirement to formally file all written materials provided to investors with the SEC is not feasible in a world where the materials are updated continuously.
- The requirement to include disclosures every time you mention a financing doesn’t work for most places those appear (try tweeting boilerplate legal text in 140 characters, or requiring reporters to include it in stories).
- These technical legal requirements place burdens on startups at a stage before they may have legal advice, and the very severe penalty for non-compliance (not fundraising for a year) is a death penalty for a not-yet-profitable business.
- Specifically relevant to AngelList, “affiliates” or “promoters” of startups that violate these rules are also subject to penalty. Given our neutral role, we are concerned that a broad interpretation there could lead us to accidentally be swept up in this. With over 100,000 companies I’m quite certain at least one will accidentally miss something and not cure with the SEC, potentially barring offerings by AngelList and all other companies listed on AngelList for one year.”
The main suggestion from AngelList to improve the proposed rule is to allow third party companies like AngelList to automatically file certain information with the SEC electronically when the material gets updated on AngelList.
Crowdentials is “a regulatory compliance software company that provides accredited investor verification services.” Not only that, it (supposedly) does so through an “inexpensive service that fully automates this process and does not require investors to disclose sensitive information like tax records.” Crowdentials is strongly in favor of the proposal to amend Form D to require issuers to identify, in Item 22, how they verified the accredited investor status of their investors.
Crowdentials even wants to impose penalties for non-compliance with Item 22 by imposing a one year ban on the use of Rule 506 for issuers who fail to complete Item 22.
CrowdCheck “provides due diligence and disclosure services for small online securities offerings.” CrowdCheck notes that many issuers are not likely to understand that videos fall within the scope of “written communications” which would be required to be filed pursuant to proposed Rule 510T. As a result, video and other common forms of general solicitation and general advertising materials (GSGA) will likely be under-reported to the SEC. There is an incentive to under-submit materials in general, since the SEC has no way to know whether all materials will have actually been submitted.
CrowdCheck contends that the iterative nature of offering materials, which are constantly being modified in online forums in real time, does not fit with this disclosure model, and that a better use of the SEC’s resources to protect investors would be to educate the business community about securities fraud and its consequences, because many small issuers do not understand a misstatement of a material fact or an omission of facts necessary to make statements not misleading as “fraud.” CrowdCheck calls for “a clear statement now from the Commission on what can be said in GSGA communications.”