On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (the “JOBS Act” or the “Act”) into law. Title II of the Act requires that the SEC revise its rules to permit general solicitation and general advertising in offerings relying on Rule 506, provided that all purchasers of the securities are accredited investors. In addition, the SEC must revise Rule 144A to permit general solicitation and general advertising. These changes eliminate two longstanding pillars of private placements -- the non-public manner of offering and the prohibition on general solicitation. The prohibition on general solicitation requires the issuer and/or its intermediaries to have a pre-existing relationship with investors. This rule has marked the fundamental divide between registered public offerings, such as IPOs, and private placements for over 60 years. The opening up of private offerings to public solicitations has significant implications for how issuers and market intermediaries identify and communicate with investors.
Most notable is the ability of issuers, including private funds (think hedge funds), to use public media to solicit investors with the only caveat being that the investors who purchase in the offering must be accredited under the net worth or income tests of Regulation D. The ability of issuers to use general solicitation and advertising promises to significantly expand the number and broaden the types of investors solicited beyond typical “angel” investors. Even though accredited, a segment of these investors are not financially sophisticated and may not understand or appreciate the risks of investing in privately-held and early stage businesses. The increased need to educate and inform this new segment of investors as to the significant risks of investing in emerging businesses will present a challenge for securities regulators as well as issuers.
The Act also created a new exemption from broker-dealer registration for any “platform” that facilitates the sale of securities in Rule 506 offerings under certain conditions. Although prohibiting these platforms from receiving transaction-based compensation or holding custody of securities or funds, the JOBS Act allows the platform to conduct “ancillary services,” including due diligence and the provision of standardized offering documents. Unlike the so-called crowd-funding portals created under Title III of the Act and registered broker-dealers, these Rule 506 offering platforms are not mandated to conduct due diligence on issuers or offering terms.
The Act provided a deadline of July 4, 2012 (90 days following enactment) for the SEC to complete its rulemaking under Title II. The SEC has missed that unrealistic deadline; however, SEC Chairman Mary Schapiro indicated at a Congressional hearing that the SEC has made significant progress on a rule proposal. On July 2, 2012, the SEC announced an open meeting to be held on August 22, 2012 to consider, among other matters, rules to eliminate the prohibition against general solicitation and advertising in offerings under Rules 506 and 144A under the Securities Act.1
The repeal of the prohibition on general solicitation and general advertising has generated significant public comment2, including rulemaking suggestions from state securities regulators and the North American Securities Administrators Association (“NASAA”). These regulators argue that since the language of Title II calls for verification of an investor’s accredited status it is clear that Congress intended this responsibility to be a step-up from the current requirement that an issuer have reasonable belief that an investor is accredited. Accordingly, in the context of Rule 506, NASAA believes that a verification of status as an accredited investor should require the production of evidence by an investor to demonstrate the requisite income level or net worth. In addition, because Rule 506 is being expanded to permit general solicitation or advertising, NASAA believes that it is now necessary to strengthen some of the filing requirements for Form D, including requiring a Form D filing before a public solicitation begins. Moreover, to make the requirement more meaningful, NASAA stated that the failure to file a Form D should result in the loss of the exemption.3
To prevent deceptive or misleading advertising in these offerings, NASAA believes that the SEC should require that advertising comply with requirements that are similar to those applicable to registered offerings. In NASAA’s view, Rule 506 offerings should be required to include, among other things, a “balanced presentation of risks and rewards,” and adhere to a requirement that statements in advertising are consistent with representations in the offering documents.
The rulemaking suggestions put forth by NASAA and state securities regulators evidence significant investor protection concerns with allowing broad-based solicitations for unregistered offerings to accredited investors, many of whom may not be financially sophisticated. NASAA and state regulators have raised additional investor protection concerns about permitting unregistered intermediaries or “portals” to facilitate public offerings that do not involve the participation of registered broker-dealer firms. Although these investor protection concerns are real, NASAA’s rulemaking proposals are not supported by the rulemaking directive of Title II, which is narrowly focused on verification of accredited investor status. Accordingly, it appears most likely that the SEC’s rulemaking will focus on the core issue of accredited investor verification standards.
The SEC has scheduled an open meeting to consider rules under Title II for August 22, 2012. It is unclear whether the SEC will propose rules at the open meeting or adopt interim final rules. In either case it is likely that additional rulemaking (and continued controversy) will follow.