I received two calls from reporters the other day. They wanted to talk about the lifting of the ban on general solicitation, which happens effective Monday, September 23, 2013.
Is the lifting of the ban on general solicitation exciting? Is it a big deal?
Why are the proposed rules bad? What is wrong with them?
First, I told them that, yes, the lifting of the ban on general solicitation is a big deal.
The reason? Because for as long as we have all been alive entrepreneurs have been hamstrung. Held down by rules and regulations. Prohibited from speaking to the public at large about what they were working on and the investment opportunity it presented.
For as long as we have all been alive, when raising money, entrepreneurs have had to work contact-to-contact, focusing on people they knew or with whom they had pre-existing relationships.
Only in the past few years have things like demo days, angel investment forums, etc., come into being.
Effective September 23rd, companies will be able to attend those events, pitch their ideas and their investment opportunities, and not worry about whether they have broken the law.
If you are not familiar with what the law says right now, it says companies can’t generally solicit or generally advertise their securities offerings. The law doesn’t actually define what constitutes “general solicitation” or “general advertising.” Instead, the SEC has provided examples:
- posting on unrestricted websites;
- advertisements published in newspapers and magazines;
- communications broadcast over television and radio; and
- seminars and meetings where attendees have been invited by general solicitation or general advertising (think demo days, etc.).
Effective September 23, companies will have a choice. They can conduct their private securities offering either in accordance with the old rules, which will be relabeled Rule 506(b) offerings and not generally solicit, or generally solicit their offerings under the new Rule 506(c) and comply with three additional obligations.
If you generally solicit, the additional obligations are: (i) you can only take money from accredited investors, (ii) you have to take reasonable steps to verify the accredited investor status of your investors, and (iii) you have to check a box on your Form D indicating whether you generally solicited.
(I have written a number of posts about what additional obligations come along with general solicitation. Check out More Questions About Generally Solicited Offerings).
WHY ARE THE PROPOSED RULES BAD?
The SEC, on the same day it issued the final rules on general solicitation that become effective September 23, issued proposed rules that would substantially complicate the general solicitation process.
We don’t know when and if the proposed rules will go into effect, but if they are adopted in the form in which they were proposed, they will substantially change the landscape in an unfavorable way for companies that want to generally solicit. In other words, the proposed rules are a take away, a retrenching of the statutory work that Congress did in the JOBS Act.
In Section 201 of the JOBS Act, the Congress directed the SEC to repeal the ban on general solicitation in all accredited Rule 506 securities offerings, so long as issuers took reasonable steps to verify the accredited investor status of their investors. (Reminder, the Congress overwhelmingly passed the JOBS Act; the House overwhelmingly passed it twice. This legislation was not a close call.)
The SEC’s proposed rules would do the following:
- Require companies to file an Advance Form D 15 days before generally soliciting
- File all written general solicitation material with the SEC before it uses it
- Prominently include legends on all written general solicitation material
- File a terminating amendment to the Form D on completion of the offering
- File a much more detailed and comprehensive Form D
- Be subject to a 1 year prohibition on using Form D if the company missed one of the Form D filing deadlines—like, not filing the Form D 15 days in advance of generally soliciting.
The startup world has been howling about these proposedrules. Fred Wilson, at avc.com said, “If the SEC’s intention, with these proposed additional rules, is to neuter General Solicitation to the point that it is legal but nobody avails themselves of it, they will succeed.”
“Practices that have worked well without incident for decades could suddenly become unintentional minefields for honest startups and sophisticated investors alike. Demo days, where startups present to investors and press, will most certainly be called ‘general solicitation’ by the law firms advising startups (and likely by SEC enforcement as well). This means that some of the most high profile ways new startups raise money transparently may now cause those same startups to go out of business if the penalties are enforced.” ~ Mitch Karpor
The SEC staff, at a public hearing on Tuesday, September 17th, wouldn’t answer the question whether demo days constitute general solicitation. They demurred. They fell back to their often stated position that what constitutes general solicitation or general advertising is a question of fact on which they can’t opine.
Yet the SEC’s final rules that go into effect on September 23rd require companies to check a box as to whether they generally solicited. How can companies comply with the law if the SEC doesn’t provide more guidance on what the law means?
At least when the IRS issues new regulations, it typically issues numerous examples showing how to apply the new regulations in particular factual circumstances. The SEC ought to do the same, especially if it is going to impose a 1 year prohibition on companies who miss a Form D filing deadline.
I pointed this out to the reporter I spoke to on the phone. I asked:
“What if a university student goes to a business plan competition? She pitches her idea. She is encouraged by her coaches in the program to describe in detail how much money her new business idea will need to get to market. She includes a slide which describes how she would propose her new business to raise money. It indicates that she will look for $500,000 in seed financing from angels. The coaches in the crowd include local VCs and angels.”
Is this general solicitation? If so, this woman probably has not filed her “Advance Form D.” Has she just blown it?
The SEC needs to tell us. You might say this is an “edge” case. I would say this kind of thing happens all the time.
Dear SEC, Don’t hamstring entrepreneurs? Please don’t re-legislate the JOBS Act? Joe.