SEC’s General Solicitation Decision: What You May Have Heard Wrong
Earlier, we posted a broad overview of this week’s historic changes to our securities laws. Today, we want to address some of the misinformation and confusion floating around – including in some well-respected media outlets – regarding these rule changes.
This is Not the Same Thing as Title III “Crowdfunding”
Last year, Congress enacted the JOBS Act to much fanfare. The JOBS Act was really a collection of several new laws, and the part that received the most media attention was the so-called crowdfunding act in Title III. Very broadly, this section creates a new offering mechanism whereby companies can solicit and accept investment from unaccredited investors – i.e. no income or wealth threshold required. It is important to note that investment crowdfunding under Title III of the JOBS Act is not yet legal, and that did not change this week. Though the law has passed, it doesn’t go into effect until the SEC writes rules to flesh it out – and the SEC hasn’t done so yet.
Rather, this week’s lifting of the general solicitation ban gives effect to Title II of the JOBS Act. Some are calling this “accredited crowdfunding”. Call it that if you wish – but understand that this isn’t the same thing as equity crowdfunding for unaccredited investors under Title III of the JOBS Act, which is not yet legal.
The Scary Stuff You Might Have Read about Form D is Not the Law. There is considerable confusion within the financial press regarding the SEC’s proposed rules concerning Form D. On July 10, 2013, the SEC issued two different releases. The first is what is discussed in Part I, i.e. the adopting release lifting the general solicitation ban. In the second, separate release, the SEC proposed new rules to beef up Form D. Form D is a “notice filing” that companies are supposed to file with the SEC when after they raise money under Reg D, including under Rule 506. Historically, Form D has been short and simple, and the penalties for failing to file the form have been minimal. But these new proposed rules change that dynamic.
The proposed revisions to Form D would require much more substantive information about the offering than is presently required. More troublesome, the proposed rules would require that the Form D be filed 15 days before any general solicitation is made – a requirement that many, including we at Grofolio, believe fundamentally conflicts with the reality of early stage companies, who tend to be more or less in permanent fundraising mode.
The proposed rules would also require that each individual instance of general solicitation (every wall post or tweet?!) be submitted to the SEC in writing before it is presented to the public. But the tweet concern may be moot anyway, because the proposed rules require that lengthy legends (warnings to investors) be affixed to all instances of general solicitation – legends that are themselves longer than a tweet.
The proposed rules further require that Form Ds be amended over the course of an offering as the circumstances surrounding the offering change, and that a “closing amendment” be filed at the end of an offering. But worst of all, by far, the proposed rules provide that if a company fails to comply with all of these complex Form D filing requirements, they will be prohibited from raising money under Reg D Rule 506 for a period of one year. Since the vast majority of private companies raise money under Rule 506, this effectively means that companies are forbidden from raising money for a year. In other words, it’s a death sentence.
These proposed rules pertaining to Form D are troublesome; we at Grofolio believe that they will inject a lot of uncertainty into the capital formation process, and risk gutting the effectiveness of general solicitation under new Rule 506-c and thwarting the Congressional intent behind the JOBS Act. But, fortunately, they are merely proposed rules at this point. The rules aren’t final, and may not ever be. The SEC works by proposing rules, seeking public comment, reviewing those comments, and then modifying, finalizing, or abandoning the proposed rules as it deems fit. The public commentary against the rule has been almost uniformly negative; you can join the chorus by submitting your comments to the SEC here.
Someday, these rules may be finalized. Hopefully, they never will be. But the thing to understand for now is that they most definitely are not binding today. So as you read up on the lifting of the general solicitation ban – and we encourage you to read up on it; there’s a lot of nuance to be captured by any one article or blog post – don’t be fooled by the misinformation that is out there. The only “bad part” of the rules that went into effect yesterday is that companies who use general solicitation to seek investors must now take “reasonable steps” to verify that those who invest are accredited investors, and can no longer rely on self-certification.
This part wasn’t a surprise; Congress mandated it in the JOBS Act. All the other stuff you might read – about Form D pre-filing requirements, about submitting solicitation materials to the SEC, about legends, about the one year “penalty box” for failure to properly file Form D – these are not yet final, binding rules, and hopefully never will be. So while they should certainly keep an eye on the Form D rules, fundraising companies should not let concerns about the new Form D prevent them from utilizing general solicitation under Rule 506-c — yet.
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.