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
Thanks for contributions to this update from my partner Knox Proctor.
The Jumpstart our Business Startups ("JOBS") Act
was a bipartisan effort to create jobs by making it easier for start-up
companies to deal with securities laws when raising capital. It was signed by the President on April 5,
2012. Most of the Act's provisions
require the Securities and Exchange Commission ("SEC") to enact rules
to implement those provisions before they become effective.
Did you ever buy a Christmas toy for your children that
had on the box the dreaded words: "Some Assembly Required?"
If so, then you will understand the current status of the
JOBS Act several years after passage:
-
Some parts appear to work as intended.
-
Some parts seem to be missing.
-
We have some extra parts that don't appear to belong
anywhere.
-
The assembly instructions were not written by native
English speakers.
The excitement of unwrapping the present wears off if
there is a long assembly process with bumps in the road.
If you cannot get your Christmas gift assembled and in
full working order before Christmas dinner, you begin to wonder:
-
Is the product defective?
OR
-
Are you just a dysfunctional assembler?
The three year delay in implementing major parts of the
JOBS Act is caused in part by both poor design and an assembler that would
really rather be doing something else.
Let's talk about our reluctant assembler first.
The SEC missed all the statutory deadlines for proposing
rules. So far only one of the SEC's
proposed rules has become effective.
That's an impressive delay strategy success rate. A football team trying to hold onto a lead
that is winding down the clock could learn a lot from the SEC. But the SEC is fighting a losing battle. The Internet and Social Media won't
disappear. There is no two minute signal
before the game ends. The influence of
Internet and Social Media grow stronger as these tools permeate our lives while
the SEC's delay and out dated interpretation of the securities laws seem more
foolish day after day. Recently, the SEC
had to surrender to Twitter by permitting issuers that use Twitter or any other
technology that limits the space you can use to link to other documents that
contain required SEC legends that are too long to fit the technology space
limitations. For example, Twitter's 140
character limit.
Temporary delays can be put in the past.
The primary issue is that some of the SEC's proposed rules
(or statements about what the SEC thinks the JOBS Act means) threaten to so
substantially limit the practical usefulness and cost efficiency of some JOBS
Act offerings that the purposes of the JOBS Act may not be achieved.
Not all the JOBS Act's problems can be blamed on a
reluctant SEC. The SEC has been able to
take positions that frustrate the purposes of the JOBS Act, because the statute
contains a number of ambiguities. In
other instances, Congress built in to the statute provisions that make the JOBS
Act very cost inefficient for businesses that are trying to raise capital.
Part of the problem was just poor draftsmanship. But the other driving force was that Congress
was split between two goals: increasing the efficiency of capital raising by
small to mid-sized businesses to defend against allegations by critics that
investor protection is being abandoned.
Investor protection forces in Congress contributed substantially to the
confusing language and unreasonable conditions, which the SEC is relying on to
create restrictive rules.
Before we leave the subject of investor protection, let us
remember that the JOBS Act did not change any anti-fraud rules. What was fraud before the JOBS Act remains
fraud after the JOBS Act. The primary
purpose of JOBS Act is to allow information to be disseminated into the market
using 21st Century technology that most people use every day for both business
and in their personal lives.
Yes, new technologies will be used to commit fraud. But old media and personal contacts were also
used to commit fraud. No system is
perfect as long as fools and their money are soon parted. But any system that tries to always protect
us from our foolish selves will unnecessarily interfere with the ability of
honest businesses to raise capital.
If we do not change the definition of fraud, advocates of
change in securities laws should remember that more information delivered to
more people faster and cheaper in the open where everyone can see it is the
best anti-fraud investor protection system.
Before we review the current status of the JOBS Act and
existing and proposed implementation rules, we should note that Congressional
Committees are working on changes to the JOBS Act. Some of these changes are required to clarify
ambiguous language in the original JOBS Act.
Other changes are necessary to offset SEC interpretations of the JOBS
Act and implementation rules that threaten to negate many of the JOBS Act's
intended benefits.
Notwithstanding our criticisms of some unnecessary
restrictions, we should note that the JOBS Act has already helped many issuers
raise capital. Rule 506 (c) offerings
that use general solicitations are growing in number and size. Likewise, many issuers have benefitted from
the new confidentiality and other rules that govern IPOs and 1934 Act reporting
by emerging growth companies. These are
substantial beneficial changes that should not be overlooked in our zealousness
to make capital raising regulations reasonable and cost efficient in light of
21st Century technology and communications tools and practices.
Although we are giving an updated overview of JOBS Act developments,
it is important to note that most of the provisions in the JOBS Act are not yet
effective. We will provide a further
update when all final regulations are in place.
Note that you will need to consult with a knowledgeable securities
lawyer before you try to take advantage of any of these provisions.
Overview of the
JOBS Act
The JOBS Act is a wide ranging piece of legislation that
amends multiple sections of both the Securities Act of 1933 and the Securities
Exchange Act of 1934. Some Sections of
the JOBS Act became operative when the statute was enacted. Other Sections of the JOBS Act instructed the
Securities and Exchange Commission to write rules implementing these sections.
We discussed above that the fundamental purpose of the
JOBS ACT was to unleash the power of 21st Century communications systems in
capital raising. The JOBS Act also tries
to make it less burdensome for smaller companies to become publicly-held and
remain publicly-held. Conversely, the JOBS
Act allows smaller businesses to remain private even if they have a relatively
large number of shareholders.
The following table summarizes the primary provisions of
the JOBS Act as well as their current regulatory status and some of the primary
issues related to using these provisions.
|
JOBS ACT SECTION
|
DESCRIPTION
|
CURRENT STATUS
AND ISSUES
|
|
Section 201(a)
|
Rule 506 Private Offerings General Solicitation and
Advertising –– Allows general solicitation and advertising of Rule 506 (c)
private offerings that are exempt from registration, if an issuer takes
reasonable steps to verify that all investors are "accredited
investors."
|
Initial SEC Rules approved July 10, 2014 in Release No. 33-9415;34-69959 and
became effective September 23, 2014.
SEC proposed additional rules on July 10, 2013 in
Release No. 33-9416; 34-69960
The initial SEC rules represent a fair attempt to
implement Congressional intent to promote capital-raising.
Investor verification rules are being implemented
without undue burdens and both the number and size of Rule 506 (c) offerings
are growing month by month as more people recognize the benefits.
Proposed SEC rules regarding changes to SEC Form D and
filing all communications with the SEC on the date they occur impose
impractical burdens that will make it difficult and more expensive for young
businesses to comply with the rules thereby exposing companies to liability
risk.
|
|
Section 201 (c)
|
Broker-Dealer Registration Exemption - Affords
exemptions from the requirement to register as a broker under Section 15 (a)
(1) of the Exchange Act to technology platform operators and people who
co-invest in issuers.
|
Became effective immediately.
SEC has not proposed any rules, but the SEC has issued
statements in FAQs that indicate the SEC believes technology platforms that
sell securities in Rule 506 offerings can only be operated by registered broker-dealers
and venture capital funds.
The primary legal issue is whether technology platform
operators should be treated like (i) media outlets or telecommunications
system operators who provide technology enabled services that permit others
to offer and sell securities or (ii) as a broker who actually effects offers
and sales of securities.
Should technology platform operators be treated more
like Merrill Lynch or more like Comcast or Verizon or the Wall Street
Journal?
|
|
Title III
Sections 301 to
305
|
Crowdfunding" –– Allows companies to obtain limited
investments (up to $1 million per issuer per year and up to $10,000 per
investor per year) from the general public (both accredited and
non-accredited investors) without registration, but through strictly
regulated crowdfunding platforms.
Rules regulate both the issuers raising capital and
crowdfunding platform operators.
|
SEC proposed rules on October 23, 2013 in Release
No.33-9470; 34-70741.
Rules not yet effective.
Primary issues with rules include"
-
Requiring reviewed and audited financial statements
increases offering expenses to a high percentage of the $1 million annual
limit per issuer.
-
Requiring annual filings with the SEC creates ongoing
expense and loss of confidentiality for issuers.
-
Limits in fees operators can charge and ownership of
issuers by platform operators limits operator profits.
-
Limiting off-platform communications by issuers
impedes the sales efforts.
-
Prohibiting platform operators from making
recommendations limits usefulness to investors who seek to find the best
investment opportunities.
|
|
TITLE V
Section 501 to
504
|
Exchange Act Triggers - Increases the maximum number of
record shareholders that, when exceeded, trigger registration and ongoing
reporting requirements under the '34 Act.
|
Rules are working as intended.
|
|
TITLE IV Sections
401 to 402
|
"Small Offerings –– Regulation A+" –– Provides
exemptions for certain smaller offerings of securities.
Primary change is to create different rules for (1)
offerings up to $5 million and (ii) offerings up to $50 million (including
$15 million of shareholder e-sales).
Also exempts the offering from certain state securities laws.
Regulation A offerings were limited to $5 million and
most issuers utilized the more flexible Rule 506 offerings, which has always
provided exemption from certain state securities laws.
Advantages of Regulation A compared to Rule 506
offerings include the ability to sell to persons who are not accredited
investors and the securities investors receive are not "restricted
securities," which makes re-sale easier if there is a trading market.
|
SEC proposed rules on December 13, 2013 in Release
No.33-9497; 34-71120
Not yet effective.
Primary issue will be whether Regulation A can compete
with: the flexibility of Rule 506 (c) offerings or the traditional IPO
process.
May be most useful for small public companies that have
some trading volume, because the securities are not restricted.
|
|
Title I Sections
101 to 108
|
"IPO On-Ramp" –– Grants relief for
"Emerging Growth Companies" in initial public offerings
("IPOs") and in their subsequent reporting and compliance
obligations.
|
Currently effective and has been utilized by most
companies that have done IPOs since it became effective.
|
We will address each of these provisions summarized above
in greater detail in this article in the order listed in the table.
For a comparison between the new rules and other
securities exemptions, check out my blog post:
Rule 506 (c)Private
Offerings General Solicitation and Advertising Provisions
July 2013 Rule Issuances
On July 10, 2013, the SEC issued three sets of rules. The first two were final rules that became
effective on September 23, 2013. The
third issuance proposed additional rules for comment. The first final rule issuance revises Rule
506 to allow general advertising. The
second final rule implements a provision of the 2010 Dodd-Frank Act
disqualifying "bad actors" from Rule 506 offerings. The third issuance proposes burdensome
additional requirements for Rule 506 offerings that utilize general
solicitation or advertising.
Verification of Accredited Investors -
General Solicitation and Advertising Final Rules
The new Rule 506 9c) allows a company to conduct a general
solicitation or advertise a private offering, if all investors are accredited
investors and the company takes "reasonable steps to verify" that all
purchasers are "accredited investors." The SEC rule includes for a non-exclusive
list of reasonable steps, including:
·
For the annual income test, reviewing copies of
an IRS form that reports income and obtaining a written representation from the
purchaser that the purchaser will likely continue to earn the necessary income;
and
·
For the net assets test, reviewing a bank,
broker or other financial statement that shows assets in excess of $1 Million
and a credit report to determine liabilities that might reduce net assets below
the $1 million level.
Of course, few people want to give private tax and
financial records to complete strangers.
Instead, under the rule, you can ask a registered broker-dealer,
SEC-registered investment adviser, licensed attorney, or certified public
accountant to verify that they took reasonable steps to verify the purchaser's
accredited investor status. These
professional can work for either the issuer or the investor or can be hired
specifically to verify all investors for the deal.
Initial opposition to the accredited investor verification
rules from angel investor groups created a false impression that the
verification rules were onerous. But the
reality is different. Many technology
platforms that conduct Rule 506 (c) offerings are automating the verification
process. The ability for investors to
have their own advisers sign a verification form minimizes privacy
concerns. Most accredited investors have
advisers who already possess the information that has to be verified.
The most significant effect of the verification rules has
been that some angels investors and angel investor groups who are not
accredited can no longer participate in some attractive deals. Knocking out some existing angel groups might
initially hurt the flow of capital, but this problem is likely to decrease
substantially over time as angel investor groups police their own membership.
Rule 506 (c)'s benefits include that lone angels have
better access to deals. Also, some
"super" angels are able to form their own investment syndicates
comprised of followers who want to piggy-back on their successful investment
track record.
You can also market to unaccredited investors (who cannot
make purchases) through Social Media and motivate them to involve accredited
investors. This provides cost-effective
marketing for many issuers who are able to identify online groups interested in
promoting their product or service.
We have seen these groups back companies on websites like
Kickstarter. We have also seen patient
groups lobby the FDA and otherwise advocate for drug companies that are working
on developing and testing drugs that could help them or their family members. People who share common hobbies or other
interests frequently share information through Social Media. These groups form communities that can be
motivated to help sell securities offerings for businesses that capture their
imagination even if all members of the community are not accredited..
Finally, Rule 506 (c) allows issuers to go around
traditional money gatekeepers (like venture fund managers and private equity)
and sell directly to the investors who traditionally invest in such funds. This provides greater ability to negotiate
better prices and more flexible deal structures. Investors can benefit from direct investments
by not paying the fees fund managers charge.
Therefore, although the world of investing is changing,
technology afforded by Rule 506 (c) is making individual investors a more
dynamic force.
For a more detailed discussion of the requirements,
including accredited investor verification rules, if you want to advertise
check out my blog post:
The General Advertising Proposed Rules
Although the SEC's initial Rule 506 rules were balanced
and reasonable, the proposed new rules for Rule 506 offerings that use
advertising would impose many additional burdens, including:
• An
advance filing of SEC Form D 15 days before engaging in general advertising;
• Additional information on SEC Form D,
which one Congressman has called a "wildly expanded" Form D;
• Use of
lengthy specific legends on written general solicitation materials;
• Submission
to the SEC of advertising materials prior to use;
• Imposition of specific time deadlines
and a disqualification period for a failure to use Form D; and,
• An
updated Form D filing at the close of an offering.
The SEC does not like general advertising and solicitation
in private offerings, and these rule proposals are an attempt to impose
registration-like requirements on these offerings and take away the benefits
intended by the JOBS Act.
Note: There
is a small window of time for Rule 506 offerings to be made without complying
with whatever rules become final imposing additional requirements for general
advertisement and solicitation offerings.
For
a fuller discussion of the Bad Actor rules, check out my blog post: http://jimverdonikintersection.blogspot.com/2013/07/secs-bad-actor-rule-when-you-lie-down.html
Deal Makers in the Rule 506 Market
You can't have a vibrant market without deal makers.
Someone has to bring buyers and sellers together so they
can do deals.
Traditionally, that was Wall Street's job. But Wall Street has merged with London,
Frankfurt, Hong Kong and Shanghai to form a global market.
Going global left a vacuum in a big part of the market for
small and mid-sized companies
A basic thrust of the JOBS Act is that general
solicitation and advertising (and more specifically technology platforms and
Social Media) are supposed to help fill this vacuum.
But technology does not work by itself. Skynet has not yet become self aware.
-
Someone has to build it.
-
Someone has to maintain it.
-
Someone has to operate it.
So, the first issue in building a vibrant Rule 506 market
is: Who is allowed to operate the technology?
Traditionally, registered broker-dealers were the market
makers.
But, both the 2008-2009 crash and many changes in
technology cause us to ask:
-
Do you really need to be a registered broker-dealer to
operate a technology platform or to use social media to bring people together?
-
Does Wall Street have the skill sets required?
-
Should we exclude people who have the required skill
sets because they are not registered brokers?
Section 203 (c) of the JOBS Act attempted to address these
types of questions by providing an exemption from federal broker-dealer
registration requirements for service providers who maintain platforms or
mechanisms that "permit"
offers, sales, purchases, negotiation and related activities with respect to
securities transactions in Rule 506 offerings and Rule 144A re-sales that meet
certain conditions.
This reform made sense, because it treats technology
platform operators and Social Media like securities laws have traditionally
treated old media and technology – like telephones, TV, radio and newspapers.
Social Media and Technology Services vs.
Broker Activities
The word in section 203 (c) that has the most legal
significance is that the platform or device "permits" the activity to occur just like traditional
media permitted securities transactions to occur. We do not require operators of telephone
systems to register as brokers even though the telephone system permits and
helps people to buy and sell securities.
The same is true for TV, radio and newspapers when they carry
advertisements.
We do not even require advertising agencies to register as
brokers even though they provide advice and services that can help sell
securities like any other product.
This raises the question: Is traditional media so
different from technology platforms that list securities offerings?
Reality TV shows like "Shark Tank" bridge the
gap that used to separate investments from entertainment. On the platform side, video is replacing
written materials at a rapid pace. Many
issuers already use You Tube to attract investor interest.
People make investments in non-public companies for many
reasons. It's not solely to obtain a
return on investment. Social Media often
mixes together investing with social causes, hobbies and other interests.
Many technology platforms are likely to specialize in
offerings that appeal to one of more of the expanding number of online
communities.
Section 203 (c) of the JOBS Act was an attempt to draw
reasonable lines between this new type of investing and traditional
broker-dealer activity.
Any regulatory framework that tries to pound the new round
way of investing into the old square broker-dealer hole will be obsolete the
day it is enacted.
Section 203 (c) also says that to be exempt, these service
providers and their employees must receive no compensation in "connection with the purchase or sale"
of these securities and must not have custody of customer funds or
securities.
These service providers and their employees may, however,
"co-invest" in these securities and may receive compensation for
"ancillary services" in connection with transactions in these
securities. Ancillary services may
include "the provision of due diligence services" but may not include
"for separate compensation, investment advice or recommendations." Ancillary services also may include "the
provision of standardized documents" subject to certain limitations.
Section 203 (c) makes perfect sense and really should not
be controversial if you look at it simply as a way to define when a platform
operator deserves the same treatment that we have long provided other media and
technology operators.
Unfortunately, the SEC does not agree with this view of
Section 203 (c).
The JOBS Act required the SEC to issue rules relating to
this exemption before July 4, 2012, but the SEC has not proposed any
rules. The SEC has, however, posted FAQs
and responses on the SEC's website.
These FAQs indicate the SEC believes any compensation other than a
co-investment is compensation "in
connection with the purchase and sale" of the securities offered
by issuing the technology platform.
According to the SEC's FAQs, TV, radio and telephone system operators
can charge fees for their services "in connection with the purchase and
sale" of securities, but Internet based service providers cannot charge
fees.
Because of the SEC's position that Section 203 (c) does
not permit platform operators to charge any fees, the SEC's has indicated that
Section 203 (c) has practical use only for venture capital investment funds who
are trying to bring outside investors into their portfolio companies.
The SEC had previously indicated in "no-action"
letters that platform operators could charge a listing fee. Therefore, the SEC's interpretation of
Section 203 (c) is somewhat bizarre. It
would require one to believe that Congress intended to restrict the ability of
people to charge for services they were already allowed to provide for a fee.
The SEC's position seems completely at odds with Congress'
apparent intent to draw a distinction between fees for ancillary services and
fees for securities sales on Rule 506 platforms. The lack of rule issuance probably reflects
the SEC's hostility to this provision of the JOBS Act while not committing itself
to rules that directly contradict the intent of the JOBS Act.
We note that the JOBS Act does not provide an exemption
from broker-dealer registration under state securities laws.
We cannot have a vibrant market in Rule 506 offerings
until the SEC recognizes that there is a legal wall between:
-
Service providers that offer technology enhanced
services that "permit" others to buy and sell securities.
-
People who use their technology enhanced services to
buy and sell securities.
The world has functioned reasonably well since 1933 by
recognizing this distinction between people who provide telephones, radio,
newspapers and TV compared to people who use these devices and services to buy
and sell securities. Likewise,
advertising agencies that shape the message are not treated the same are people
who buy and sell securities. The world
will not fall apart by extending this same principle to internet platforms and
Social Media and the people who provide these services.
Crowdfunding
Provisions
The Basics –– Platform Operators and Issuers
"Crowdfunding," the idea of selling small
securities offerings in small increments, may have received the most hype of
all of the JOBS Act provisions. It will
not be effective until the SEC implementing rules become final. "Crowdfunding" will provide for
exemptions from both the Securities Act and the Exchange Act, and preempt state
securities laws, but will be subject to a great number of conditions. The conditions in the law are already heavy,
and the final rules may increase the burden on both crowdfunding platform
operators and issuers who sell securities on crowdfunding platforms.
We will talk about issuers first.
Problems with Crowdfunding Rules
for Issuers
A Crowdfunding issuer may sell no more than $1 million in
securities in any 12-month period, with each investor limited to investments
of:
·
For an investor with an annual income or net
worth of less than $100,000 – the greater of $2,000 or 5% of the annual income
or net worth of the investor; and,
·
For an investor with an annual income or net
worth greater than $100,000 – 10% of the annual income or net worth of the
investor, subject to a $100,000 limit.
These dollar amounts will be subject to consumer price
index adjustment every five years.
Many of the disclosure requirements for crowdfunding
issuers make disclosure sense and do not impose unnecessary burdens But several provisions will make crowdfunding
unnecessarily expensive in light the $1 million annual limit. The biggest expense is accounting. Reviewed and audited financial statements are
expensive. But the issue goes beyond the
checks issuers will have to write to their accountants. The financial statements requirements reflect
a deep misunderstanding of how small and young businesses actually operate.
Limited liability companies and other tax pass through
entities usually do tax cash basis accounting, not accrual accounting using
GAAP. Forcing young businesses to change
the way they do business will discourage use of crowdfunding and add to
operating expenses. Doing GAAP compliant
financial statements requires more than paying an auditor. You have to have
internal people and systems. Auditors
always remind their clients that the financial statements are the work of the
client. Independent auditors only audit
the accounting work their clients perform.
The SEC recognizes this distinction in roles and auditors can lose their
independence if they cross the line and audit their own work.
From the investor's perspective, GAAP compliant financial
statements are often unnecessary. Most
investors in young businesses want to know if there are any major liabilities
that will eat into the investment proceeds and then focus on financial
projections. Past operating performance
for a business that is doing R & D and has to yet launched a product or that
has only launched a beta version is less material to investors than in a mature
business.
Treating pre-revenue businesses like they are doing an IPO
is not a practical approach to capital raising problems.
The other major expense disclosure issue is the
requirement to file annual reports, including financial statements, with the
SEC. We often focus on issuer objections
to annual reporting. But the bigger
issue is investors. Smart investors will
not want to finance this expense and will worry that competitors will use this
information against the issuer.
If the initial investors are not smart enough to have
these concerns, then what about future rounds of investors? Will the annual reporting requirement doom
future fundraising efforts? If so, then
the annual reporting requirement is likely to harm the interests of the initial
crowdfunding investors.
If these issues are of concern to both smart issuers and
smart investors, then who will use crowdfunding?
-
Desperate issues.
-
Unsophisticated investors.
This potential for a toxic downward spiral in the quality
of both issuers and investors makes you wonder whether the people who designed
these rules were really interested in promoting crowdfunding or burying
crowdfunding. Mark Anthony's funeral
speech for Caesar comes to mind.
Problems with Crowdfunding Conditions for
Platform ("Portal) Operators
Another basic limitation on issuers is that Crowdfunding
may be conducted only through intermediaries who must be registered brokers or
registered as "funding portals."
A "funding portal" is a new type of intermediary
that will be registered with the SEC and FINRA and for which the SEC and FINRA
will establish a separate regulatory scheme.
the registration process for funding portals is supposed to be easier than
for a full broker-dealer registration and funding portal operators do not have
to comply with all broker-dealer rules.
Funding portals that are not also fully registered broker-dealers will
not be permitted to:
·
Collect success fees based on a percentage of
the securities sold.
·
Offer any advice or recommendations about
securities;
·
Solicit any offers to buy securities;
·
Compensate personnel based on sales of
securities; or
·
Handle any customer funds.
That's kind of like wearing a police offer's uniform, but
not being allowed to carry a gun.
Before we discuss the rules that relate to crowdfunding
platform operators, let's briefly discuss the theory behind crowdfunding. Traditional securities laws pushed investors
to rely on "experts" – registered broker-dealers and investment
advisers. These professionals acting in
accordance with SEC rules were supposed to protect investors. Of course, events leading up to the 2008-2009
financial crash showed that relying on highly regulated Wall Street to protect
investors is a fool's errand.
Crowdfunding is based on the theory that the
"crowd" of fellow investors protect one another. This is accomplished by putting a securities
offering up for comments by the crowd of investors. Some people in the crowd will have positive
comments about the offering. Other
people in the crowd will have negative comments. The crowd can ask issuers questions. All of these interactions can be viewed by
everyone else in the members of the crowd.
We should judge whether crowdfunding rules are reasonable
based on the extent to which the rules promote interactions among an informed
crowd.
Therefore, requiring the issuer and its agents to identify
itself when making comments makes sense.
So does requiring all comments to be open to all members of the crowd.
But a host of other rules have little to do with promoting
a healthy crowd.
Let's consider some examples.
-
Rules against a platform operator owning equity in an
issuer and rules against platform operators collecting success fees only serve
to limit the amount an operator can profit from any single issuer. This means that to be profitable a platform
operator must attract a very large number of issuers. Having a large number of issuers forces
investors to spend more time sifting through deals and less time analyzing
deals. Why does this help investors?
-
Rules that prohibit the platform operator from
providing investors tools to search by the size of the issuer or by the
profitability of the issuer only serve to force investors to look at more deals
than they want. Platform operators can
only offer investors generic categories of issuers, such as by industry or by
geography. This would be the same as
imposing a rule that a real estate website can only allow users to search for
potential properties by neighborhood, but cannot allow users to search for an
apartment, condo or house by the number of bedrooms or by the price. No one operates this way, because it is not
user friendly. Why waste investors'
time?
-
Because the SEC thinks platform operators should not
make recommendations, the rules discourage platform operators from conducting
due diligence, screening issuers based on due diligence, or sharing due
diligence results with investors. How
does limited due diligence help investors.
With these restrictions on user-friendliness and utility,
the launch of the initial crowdfunding portals may resemble the launch of
another Government designed website –healthcare.gov. Frustrated users unable to find what they
want is not a way to run a capital raising system.
Regulation A+: Is
it Resurrection Day or More Endless Walking Dead?
The JOBS Act amends Section 3(b) of the '33 Act to require
that the SEC issue rules that will exempt "small offerings" from
registration under certain conditions.
In a big family, you can get lost if you aren't as
assertive as your brothers and sisters.
Middle children struggle to let the world know they exist. Regulation A has been like an introverted
middle child since Regulation A was first issued several decades ago It never caught on as a major financial
vehicle. Since then, several attempts
have been made to revitalize Regulation.
All have failed.
·
SEC Rue 506 has monopolized the lion's share of
unregistered offerings because of its flexibility.
·
Companies that are willing to file offering
documents with the SEC have preferred to bite the bullet and file a full
registration.
·
Many issuers that want a quick way to become
choose to merge with a public shell company or file a Form S-1 registration
statement without an underwriter.
These other choices mean that few issuers have wanted to
do Regulation A offerings.
But someone somewhere in Congress never seems to give up
on Regulation A
Prior to the JOBS Act, Section 3(b) of the '33 Act allowed
the SEC to provide exemptions from registration if certain conditions were met,
subject to an aggregate $5,000,000 limit.
The SEC issued "Regulation A" under this Section, but this
exemption is basically useless because of several burdens and limitations,
including the rather small $5 million limitation and the lack of an exemption
from state securities laws.
The JOBS Act requires the SEC to issue rules, which some
are calling "Regulation A+," that will allow a company to issue
exempt securities under the following terms and conditions:
·
An aggregate limit of up to a $50 million per
year (to be adjusted every two years);
·
The securities issued will be "covered
securities" so that state law registration requirements will be preempted;
·
The exempt securities will be limited to equity,
debt, and convertible debt securities, and may be further limited by the
SEC;
·
A public offering and sale will be allowed;
·
The exempted securities will not be subject to
resale restrictions imposed by the current securities laws, but the anti-fraud
provisions of current securities laws will apply;
·
"Testing the waters" will be allowed,
subject to conditions to be imposed by the SEC by rule;
·
Audited financial statements will be required to
be filed with the SEC; and,
·
Other terms and conditions to be imposed by the
SEC must be satisfied. The SEC is
specifically authorized to:
o Require
offering statements to contain such content as it deems appropriate;
o Impose
disqualification provisions it deems appropriate; and,
o Require
periodic disclosures it deems appropriate.
There was no deadline for the SEC to issue these
rules. It finally issued proposed rules
on December 18, 2013. These rules have
not yet become effective.
The proposed Regulation A+ creates two tiers of Section
3(b) securities, one for offers up to $5 million and one for offers up to $50
million. The first tier essentially
preserves the old, useless Regulation A, including state securities
review. The North American Securities
Administrators Association promises to develop an enhanced plan of
"coordinated review" to make state "blue sky" review less
burdensome, but don't hold your breath.
The proposed Tier 2 offerings would be available as
contemplated by the JOBS Act with the following additional limitations:
·
It would not be available for asset-backed
securities;
·
Sales would be limited to 10% of the greater of
a purchaser's annual income and net worth, based on the purchaser's
representations (calculated as described above for Regulation D offerings);
·
Sales by selling shareholders would be limited
to $15 million; and
·
Financial statements must be audited in
accordance with PCAOB standards.
Regulation A+ offerings will be much more time-consuming
and costly than private offerings under Rule 506. The reporting requirements are similar to
those the SEC imposes on "smaller reporting companies."
So, why would an issuer consider using Regulation A+
instead of a Rule 506 offering? An
issuer might wish to be able to solicit retail investors and to be able to test
the waters prior to preparing and filing offering materials, both of which will
be allowed under Regulation A+, subject to certain filing and disclaimer
requirements. Although Regulation A+ is
costly and burdensome, it is less so than a registered offering. The securities sold in a Regulation A+
offering will not be restricted securities, which may appeal to investors
(though the securities probably will not be listed on a securities exchange
following a sale).
One big potential problem with Regulation A+ is '34 Act
registration. The JOBS Act provided that
Crowdfunded shareholders would not count against the cap for '34 Act
registration, but made no similar provision for Regulation A+ offerings. If an issuer raises $50 million in capital ––
especially with the SEC's new 10% limitation on the greater of income and
assets –– it is extremely likely that an issuer will exceed even the new,
higher limits (discussed below) for '34 Act registration. These requirements, even with the benefits of
Emerging Growth Company treatment discussed above, would be somewhat more
burdensome than the reporting requirements imposed under Regulation A+. The SEC seems disinclined to modify the
exchange act triggers for Regulation A+ offerings.
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
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