SEC’s General Solicitation Decision: What Does it Mean?
If you follow the private investment marketplace, then you know that September 23, 2013 was a historic day. On this day, the rules implementing “Title II” of the JOBS Act became final. This meant that for the first time since the Great Depression, companies seeking to raise money can “generally solicit” investors, without jeopardizing the validity of their offering. So what exactly does that mean?
Reg D Rule 506
At the outset, we note that this entire discussion applies specifically to unregistered private securities offerings conducted under Rule 506 of Regulation D. This is by far the most common mechanism for small and emerging companies, as well as investment funds like hedge funds and private equity funds, to raise capital. Fundraisers have always been able to, and still can, register their offerings with the SEC and then raise money via public offering — think IPO. But this process is generally too expensive and cumbersome for small and mid-sized companies to utilize, and as such they instead tend to rely on Reg D offerings to raise capital in the private markets.
Lifting the Ban on General Solicitation
Historically, a company raising money could only reach out to potential investors with whom the company has a “substantive, pre-existing relationship”. It couldn’t use advertising, social media, or any other public communication to reach potential investors, as this would render the offering no longer “private” (without going into the weeds of securities law, just take our word that’s a bad thing). As of September 23, 2013, however, the prohibition on general solicitation has been lifted, and companies can publicly proclaim that they are seeking to raise money, including to persons with whom they have no prior relationship, without jeopardizing the validity of their private offering under Rule 506.
This is a reversal of 80+ years of securities regulation, and is a big deal. Many – including we at Grofolio – would argue that this represents an important step towards bringing our securities laws into the 21st century, where open communication via the internet is rapidly becoming the norm.
But There’s a Catch
Unfortunately for fundraisers, Congress built a quid pro quo into the new law. Reg D Rule 506 has always been available only to investors who are “accredited”; i.e. only people who meet certain income or wealth requirements can invest in these offerings. The new rules do not change this. However, under the old, “quiet” Rule 506 (now named Rule 506-b), issuers could generally rely on “self-certification” from investors – if an investor swears that she is accredited, companies have been allowed to rely on that affirmation in most instances. By contrast, companies that avail themselves of their right to generally solicit under new Rule 506-c must take “reasonable steps” to verify that those who invest are accredited investors, and the SEC has made it clear that “reasonable steps” in this context means more than asking the investor to check a box or otherwise certify that she is accredited.
Instead, more evidence is needed — think tax returns, brokerage statements, a certification from the investor’s lawyer or financial adviser, etc. Some believe that this requirement will have a chilling effect on investment, as investors won’t want to share this information with a company they are investing in. We at Grofolio believe that any chilling effects will be far outweighed by the increased reach afforded by general solicitation, and that even if investors refuse to share sensitive financial information with the companies they invest in, they will get comfortable with sharing such information with heavily regulated intermediaries and service providers like broker-dealers and lawyers.
We at Grofolio are very excited about the lifting of the general solicitation ban for Reg D Rule 506 offerings. We believe this development will greatly increase the efficiency of our capital markets, enabling everything from start-ups to growth companies to hedge funds to raise needed capital, while simultaneously providing investors with greater access to these types of private investments than ever before.
The heightened verification standards are burdensome, but we believe that sophisticated market participants will find ways to make verification palatable to investors by creating solutions that protect the confidentiality of investors’ sensitive information. On the whole, we believe the lifting of the general solicitation ban will transform the process of raising money for, and investing in, private companies and funds – “game changer” is cliché, but apt. We are excited about the possibilities, and believe that our nation’s entrepreneurs and investors should be as well.
Preview of Part II
Next, we will post a companion piece to address some of the misinformation that is being circulated in the press regarding the lifting of the general solicitation ban, so keep an eye out!
Shane Fleenor is the founder of alternative investment marketplace www.Grofolio.com, which is an investor-centric portal that makes it easy for accredited investors to find and invest in alternative assets to achieve true portfolio diversification.