On March 15, 2010, Senate Banking Committee Chairman Christopher Dodd (D-CT) unveiled the Restoring American Financial Stability Act of 2010 (the Dodd Bill), which is aimed at strengthening the U.S. financial system and preventing future crises. In addition to significant reforms aimed at executive compensation, proxy access and corporate governance, the Dodd Bill proposes to modify the existing federal preemption of state securities laws with respect to private securities offerings pursuant to Regulation D under the Securities Act of 1933, as amended (the Securities Act). These changes would re-open the door to the old “blue sky” filings and requirements that were applicable prior to the federal preemption provisions of the National Securities Market Improvement Act of 1996 (NSMIA).

An issuer may conduct a private placement of securities that is exempt from the federal registration requirements under the Securities Act. Section 18(b)(4)(d) of the Securities Act (adopted under NSMIA) preempts state regulation of Regulation D offerings by providing that no state may require registration or qualification of an offering of “covered securities,” which includes securities exempt from registration under Section 4(2) of the Securities Act.

Section 926 of the Dodd Bill proposes an amendment to Section 18(b)(4) of the Securities Act, which would make private offerings less efficient by subjecting such offerings to SEC review, and potentially duplicative and inconsistent review by the states. Senator Jeff Merkley (D-OR) stated in his majority statement introducing the Dodd Bill that “[w]e have seen the destruction wrought by dismembering our regulatory system and taking cops off the beat” and his strong belief in putting the “50 cops [back] on the beat” to protect their citizens. Senator Merkley’s comments imply that a purpose of Section 926 is to address the recently unveiled abuses by promoters of ponzi and other schemes.

Section 926

Under Section 926, the SEC will review all Rule 506 offerings within 120 days of filing the Form D for such transaction. If the SEC fails to review the filing within 120 days, the securities will lose their status as “covered securities” exempt from state regulation unless a state securities commissioner (or equivalent state officer) determines “that there has been a good faith and reasonable attempt by the issuer to comply with all applicable terms, conditions and requirements of the filing” and that any failure to comply therewith is “insignificant to the offering as a whole.”

The proposed amendment also authorizes the SEC to designate certain securities as excluded from the category of “covered securities,” thereby excluding such securities from federal preemption under the Securities Act. In making this determination, the SEC will consider the size of the offering, the number of states in which the securities are being offered and the nature of the persons to whom the securities are being offered. Section 926 also permits states to impose notice filing requirements on issuers.

Opposition

The following publicly available letters have been sent opposing Section 926:

  • from the Securities Law Committee of the Business Law Section of the Washington State Bar Association to Senator Dodd; and  
  • from the Financial Services Roundtable, Investment Program Association, National Association of Real Estate Investment Trusts, Private Equity Council, Real Estate Investment Securities Association, The Real Estate Roundtable, Securities Industry and Financial Markets Association and the U.S. Chamber of Commerce to Senator Harry Reid (D-NV), Senate Majority Leader, and Senator Mitch McConnell (R-KY), Republican Leader.

While the Washington State Bar Association letter stresses the impact Section 926 would have on small businesses and the latter letter focuses on private offerings generally, both letters emphasize Section 926’s ambiguity and the negative impact it would have on many companies’ ability to raise capital from private sources.

Looking Ahead

The Dodd Bill is generally receiving support among Democrats, but has yet to be endorsed by any Republican member of the Senate Banking Committee. Passage of the Dodd Bill in its current form in its entirety is uncertain. If enacted as drafted, Section 926 would result in greater oversight of private securities offerings by the SEC and the states, as well as uncertainty, delays and increased costs in conducting certain private offerings.