By Jim Verdonik
I'm an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals, have authored multiple books and teach an eLearning course for entrepreneurs. You can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccessor or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW
Do you like movies about time travel?
You know the basic plot.
A character goes into the future or into the past and doesn't understand how anything works.
The SEC has been trapped in a Grade B time travel movie since the Internet arrived. It keeps trying to squeeze a big free flowing Internet into the same old securities laws and rules.
People used to communicate with one another by sending a letter or calling one person on a telephone. The SEC is having a difficult time adjusting to a more complex world of shared communications to multiple audiences the Internet created.
The SEC might not understand how the Internet changed the way we communicate and how to adapt capital raising laws to this new world. But we have proof the SEC knows the Internet exists:
- The SEC has a website.
- Public companies file their disclosure documents with the SEC over the Internet.
- The SEC even permits you to deliver proxy statements and annual reports to shareholders over the Internet.
But the SEC just doesn't understand why the Internet (and social media in particular) have changed how people think about and use communications.
That's why the SEC is proposing rules for selling securities in private placements that are very unfriendly to using the Internet generally, or social media in particular.
Does the SEC believe the Internet and social media are temporary?
Or does the SEC believe the Internet and social media can be locked in a corner by rules?
Here's another question:
Can you imagine a country that spends tens of billions of dollars every year to improve communications, but prohibits businesses from using that investment to raise the capital needed to grow the economy?
Let's explore how this crazy country decided that people can use the Internet to:
- Watch mindless movies.
- Buy porn.
- Make snarky comments about how someone dresses.
But can't use the same tools to raise capital to create JOBS.
Scope of this Article
In July 2013 the SEC made the biggest changes to private placement capital raising rules since the SEC issued Regulation D more than three decades ago by changing to Rule 506.
See the end of this article for links to other articles about these Rule 506 changes.
In this article, we'll talk about:
- Why is the SEC finding it difficult to adapt securities laws to the Internet and social media?
- How do you navigate through private placements while the SEC and state securities regulators go through a long process of adjusting to the modern world?
- Why will the SEC eventually give up?
If you are a parent, this time period might remind you of the "terrible twos." Your goal is to survive while your child adapts to new realities. During this process, focus on the fact that the SEC is just one of many organizations that are trying to adjust to media changes. The adjustment period may be unpleasant, but it remains as inevitable as growing up.
Simple Securities Rules for Simpler Communications Tools
Securities rules for using technology and media in private placements used to be so simple:
- Yes you can call up someone you know on the telephone and ask them to buy securities in your private placement, but you can't call everyone in the telephone directory.
- No, you can't advertise your private placement on TV or in the newspaper.
- Yes, a broker can mail a private placement memorandum to its customers.
- No, you can't do mass mailings to everyone in your town.
That system had its drawbacks, because it limited people's ability to raise capital. If you didn't know a lot of wealthy investors, it was difficult to raise capital. Poor people missed out on opportunities to raise capital that rich people had through their network of other wealthy people and business contacts.
That system was imperfect, but at least it reflected some basic realities about how people actually communicated with one another in their daily lives using the old technology and media.
Telephone and the U. S. mail (which in securities laws were called "instruments of interstate commerce") usually involved a communication from one person to another specific person. These communications channels were controlled by the Government and big corporations who attracted mass audiences.
Ordinary people didn't usually transmit personal messages over TV and radio or national newspaper chains. Only very large businesses could afford to advertise in the mass media.
So, everyone had an assigned place in media and securities laws created rules for operating with their assigned space.
That work until the Internet arrived. It worked because securities laws generally permitted people to raise capital by using the same tools they used for other purposes in their daily lives.
Now, the US Postal Service is going broke, because users have abandoned it for the Internet and social media. The once huge broadcast TV audience has broken into dozens of sub-groups that spend their time watching hundreds of cable stations, streaming video from the Internet, communicating thoughts and images to a mass audience and interacting with one another using multi-player computer games.
This is not merely a change in communications channels. What happens in these new communications channels is radically different than what preceded it. These differences are changing how people interact with one another.
- Users no longer passively check to see what a small group of executives decide is "on" at specified times. Users proactively search for what they want ad get it when they want it. And once they find what they want, the experience is much more interactive.
- People have changed from being consumers to contributing content.
- Most people are skeptical of what they see. They know other people like themselves create content. They can usually also find contradictory information just a few clicks away.
- Modern communications are no longer one-way or even two-way streets. Multiple people join in and then drop out.
- There are very few traffic cops that tell you where and when you can go. Freedom has replaced controls. It's all going on automatically. Or you just invest a few simple clicks.
- You no longer control where what you are saying goes. Once you say something, it can take on a life of its own. It's more difficult now to pull the plug and turn it off and on. What had been discrete private communications have morphed into shared experiences.
- Your audience is more diverse. In the old days, securities laws let you tell your neighbors you were raising capital to grow your business. But today, your new neighbors include people in multiple cities, states and countries. You can talk with them easily about just about any subject. But the SEC says not to talk to your Internet based network about raising capital to start or grow your business.
- People regularly communicate with "friends" they have met in person only once or may never have met in person.
- Bright lines no longer separate our personal lives from our business activities. Personal and business have melded together. So, it's not natural to isolate capital raising from your expanded social network.
- Computers are working 24 x 7 to expand our personal and business networks. Everyone is LinkedIn. These computers don't wait for us to contact them. They initiate contact with us, tell us how many contacts we share with other people and constantly ask us whether we want to connect to someone or endorse someone else's skills. There's no reason to think computers can't also ask us whether we want to make an investment. Why should investments be the only thing computers can't ask us about?
- Ordinary people have hundreds (or sometimes even thousands) of "followers" and in turn follow hundreds of other people on Twitter. Your tweets go to all your followers, who in turn often forward your tweet to their followers. You can easily communicate with thousands of people you don't know.
- Video is replacing plain text as a preferred means of communicating. Guttenberg's printing press that revolutionized 15th century Europe is being replaced. Videos now give us the ability to connect with many people, who all feel a greater personal connection to us than if we wrote them a letter. If a picture is worth a thousand words, a good video might be more powerful than a million words.
- Search engines allow people to find you and what you are saying. Taking it off your website doesn't even stop the search engines. Anything you ever said can be found long after you stopped saying it.
SEC rules about private placements were formulated in a world where privacy was the norm. Most things people did were private. You had to go out of your way to get public attention. That made SEC private placement rules more reasonable limitations on every day activities.
- Telling someone they can't go swimming in a desert isn't such a big restriction.
- Telling someone who lives on an island they can't go in the water can create major problems.
Given all these changes in technology and social media, people no longer have a reasonable expectation of privacy in their normal communications.
You might have privacy if you withdraw totally from modern life, but should securities laws be based on the assumption that people who need to raise capital are the modern equivalents of hermits? Even people who went into the desert to fast for forty days and forty nights sometimes emerged as prophets. Their few words after they reemerged into civilization sometimes spread far and wide.
In today's world, everyone is a publisher. And you don't just publish important things. If you just exist, it's reasonable to expect that other people will know what you are doing. When you wrote a letter to someone or called them on the phone, you didn't expect that person to send copies to dozens of people. Social conventions have changed. People feel perfectly free to share your communications with others. In some forms of social media, it's impolite not to pass along what other people send you.
Sharing communications through multiple contact networks is the name of the game. Modern life depends on it. Traditional securities laws are interfering with that basic process.
That's why Congress and the President told the SEC in the JOBS Act that the SEC can no longer pretend it's 1933. The rules for communicating in private placements have to let people use the systems they use for communicating other things in their daily lives.
The SEC has responded to legal mandates by taking the first baby steps to allow advertising and general solicitations in Rule 506 (c) private placements. But the SEC hasn't really changed its mind. The SEC still likes living in the past. So, the SEC is reluctantly doing the minimum the JOBS Act requires it to do. But the SEC is also erecting barriers to using social media in the hope that it can still pretend the world hasn't changed.
Why do I think the SEC is erecting barriers?
In July 2013, the SEC proposed new rules that will require you to give the SEC 15 days notice before you begin advertising or conducting a general solicitation. For most young businesses, 15 days is an eternity. Waiting 15 days to even start your offering may cause a young business major cash flow problems.
Then you must file each communication with the SEC the day you use it.
Then you must file each communication with the SEC the day you use it.
- What do you think the chances are that people will file all their tweets with the SEC?
- How about each time you change your LinkedIn business profile to refer to capital raising or to describe your experience that people will use to investment decisions?
- What about each website update?
People tweet back and forth multiple times during a sporting event or about breaking news stories. These types of barriers will make social media ineffective capital raising tools and will lead to inadvertent violations by young businesses.
Another SEC proposal is to require warning legends on all offering advertisements. The number of characters in the legends is bigger than the size of a tweet. So, it would be impossible to tweet the SEC's legends. Of course, Twitter has the most limited space limitations. But most social media involves relatively short messages. That's because people browse social media quickly. They usually want to get in and get out quickly, because so many people are communicating with one another that you don't want to commit to any individual communication for too long.
In light of both time and space constraints, one can only conclude the SEC is proposing to use indirect means to prohibit using social media in adverting in private placements.
And who gets hurt the most by that? The smallest businesses with the lowest advertising budgets. Bigger companies can afford traditional advertising media but smaller and young business usually can't. So, the SEC's proposed rules continue the advantage that big companies have over their smaller competitors.
So, we're all going to have to live with the discomfort of continually pushing up against artificial barriers to raising capital as the SEC and state securities regulators gradually understand that people won't take them seriously until they create rules that make sense in light of how people actually use the Internet and social media.
This situation will last until the staff of the SEC becomes sufficiently embarrassed by the SEC's refusal to deal with reality.
Articles in Private Placement Series
In July 2013 the SEC made the biggest changes to private placement capital raising rules since the SEC issued Regulation D more than three decades ago.
More than 90% of private securities offerings are affected by these changes.
The SEC's recent changes are a mixed blessing for businesses selling securities. These changes include:
- Prohibiting using Rule 506 if someone affiliated with your business or with your capital raising efforts has violated securities or other financial industry laws.
- Adding new Rule 506 (c), which allows you to advertise when you raise capital in a private placement.
- Rule 506 (c) also requires you to take reasonable steps to independently verify that all people who buy securities are "accredited investors," if you advertise your offering.
Our articles in this series about SEC Rule 506 private placements help you decide how you can use these new rules to raise the capital your business needs by balancing three competing factors:
- Advertising effectiveness
- Securities law compliance
You have to get all three right to successfully raise capital.
Here's a list of our articles that discuss the primary issues you will face when you try to balance these three objectives in your capital raising efforts:
- Advertising Messages Tweeting Your Way to Securities Fraud in 140 Characters: What Do you Say in SEC Rule 506 (c) Advertising in Private Placements? How do you decide what you say in your advertising? How do you say it? What current SEC and state advertising rules can you use to guide your advertising decisions? Can you combine effective sales messages with complying with securities laws? Or is it an either or choice? What's the point of advertising if securities laws prevent you from selling effectively? http://jimverdonikintersection.blogspot.com/2013/08/tweeting-your-way-to-securities-fraud.html
- Choosing the Right Media for your Advertising. Don't Tweet when You Should Have LinkedIn: Choosing Your Advertising Media in SEC Rule 506 (c) Private Placements How do you advertise within your budget? How do you identify your "sweet spot" target investors and the right media to reach them? What social media tools can you use? How do you attract accredited investors who meet SEC criteria for making investments? http://jimverdonikintersection.blogspot.com/2013/08/dont-tweet-when-you-should-have.html
- Building your Sales and Legal Team. Would You Let Your Lawyer Run Your Sales Department? How Can You Build the Right Team for Advertising in SEC Rule 506 (c) Private Placements? How do you build teams to help you do effective advertising while still complying with SEC and state anti-fraud rules? What role should your sales team play? What role should your lawyer play? How do you choose a lawyer who can help you create effective advertising that also complies with securities laws. http://jimverdonikintersection.blogspot.com/2013/08/would-you-let-your-lawyer-run-your.html
- Accredited Investor Verification. Will SEC Rule 506
(c)'s Permission to Advertise Cure Your Capital Woes or is Its Accredited
Investor Verification Requirement a Poison Pill? If you want to
advertise your securities offering, you must take reasonable steps to
verify that everyone you sell to is an "accredited
investor." You can't just rely
on the investor checking a box that tells you it is accredited. How much checking is
"reasonable"? How do you
qualify for the "safe harbor" the SEC included in Rule 506
(c)? What happens if you don't
obtain the right type of proof that the people you sell securities to are
Why will some investors refuse to comply with your verification
requests? What can you do to
reassure investors about privacy issues and make the verification process
more convenient for investors?
- Beware of SEC Integration Rules: SEC RULE 506 (c) Integration Pitfalls: Don't Use the SEC's New Advertising and Solicitation Private Placement Rule to Saw Off the Limb You are Sitting On Why should you look before you leap into advertising? What integration and related pitfalls does Rule 506 (c) create for businesses that choose to advertise or engage in general solicitations? How do you sell securities to people who are not accredited investors under another SEC private placement exemption, if your advertising doesn't attract enough accredited investors to finance your business? http://jimverdonikintersection.blogspot.com/2013_07_01_archive.html
· Getting Caught : How Will the SEC Know I'm Advertising in a Rule 506 (c) Private Placement? How will the SEC know about your advertising? Why isn't it a defense that everyone else is breaking the rules? How do you deal with the interim period when people are figuring out what the new rules let you do and don't let you do? http://jimverdonikintersection.blogspot.com/2013/09/how-will-sec-know-im-advertising-in.html
· Bad Actors: SEC's Bad Actor Rule: When You Lie Down with Dogs Expect to Get Fleas To use Rule 506 (with or without advertising) you have to verify that a long list of people who are affiliated with your business or with selling your securities offering haven't violated securities or other financial industry laws. How do you make sure the SEC's Bad Actor Prohibition for Rule 506 private placements from cut off your ability to raise capital? http://jimverdonikintersection.blogspot.com/2013/07/secs-bad-actor-rule-when-you-lie-down.html
- Identity Crisis at the SEC: Does Filing Your Private Placement Tweets with the SEC make Sense? What road blocks to effective advertising in private placements is the SEC erecting? Why are these blocking efforts doomed to fail? http://jimverdonikintersection.blogspot.com/2013/09/does-filing-your-private-placement.html
- Government Bouncer at the Capitalist Club: SEC RULE 506 (c): Who is Allowed to Be a Capitalist? Why is the Government using Rule 506 (c) to decide who is allowed to be a capitalist? Do you have what it takes to get past the Government bouncer standing in your way at the door to the capitalist club? Why can't you be a capitalist too? http://jimverdonikintersection.blogspot.com/2013_09_01_archive.html
If you would like to learn more about learning how to grow your business or other issues important to your success, you can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccess or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW