Depending on your perspective, lifting the ban on general solicitation and advertising for private offerings is one of the most anticipated or feared provisions in the JOBS Act. Consumer protection groups are aghast at the potential of fraud stemming from startup companies hawking their stock to unsophisticated investors. Pro-business groups are ecstatic that someone finally had listened to their complaints about the trouble entrepreneurs have raising capital once they have exhausted their family and friends. Well, after today’s Securities and Exchange Commission meeting, it looks like the pro-business groups got a further victory. Or did they?
This morning, the Commission proposed rules to implement Section 201 of the JOBS Act to remove the prohibition on general solicitation and advertising in private offerings when all purchasers are accredited investors. While removing a ban seems relatively simple, Congress instructed the Commission to write rules to “require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.”
What constitutes “reasonable steps” is the only difficult interpretation that the SEC had to make. There was some concern that the “reasonable steps” could be as harsh as requiring investors to prove their net worth through bank statements; however, the proposed rulemaking takes a much more flexible approach. The proposed rules require issuers to make an objective determination based on certain factors:
- The type of purchaser and the type of accredited investor that the purchaser claims to be;
- The amount and type of information that the issuer has about the purchaser; and
- The nature of the offering, including the manner in which the purchaser was solicited to participate in the offering and the terms of the offering such as the minimum investment amount.
The Commission didn’t set forth specific required verification methods because it felt a “one-size-fits-all” approach would be overly burdensome, impractical and ineffective. At first glance this seems like a very issuer friendly approach. On the other hand, securities lawyers, protecting issuers from the inherent risk of securities law, do not value uncertainty, originality, or creativeness. To be truly investor friendly, the Commission should have offered some safe harbors to allow issuers to have certainty that they have taken “reasonable steps” to verify that the purchasers are accredited investors. Without safe harbors, prudent issuers may be faced with two unappealling choices: either electing not to use general solicitation and advertising or going beyond what may be “reasonable” to ensure that the offering qualifies for the exemption.
Eventually, there will likely be a consensus in practice as to what constitutes “reasonable steps.” Until then, the SEC provides the following advice:
- “Reasonable steps” is an objective determination based on the particular facts and circumstances of each transaction;
- The more information you have indicating an investor is an accredited investor, the fewer steps you would need to take, and vice versa;
- Example information you could gather: publicly available information in government filings, copies of Forms W-2, and verification of a person’s accredited status from a third party such as the investor’s broker, accountant, or attorney;
- Soliciting though a website or social media will require more verification than if the investor was solicited through a pre-screened database of accredited investors;
- High minimum investment amounts for an offering are more likely to be met by accredited investors and therefore, less steps may need to be taken to verify; and
- Issuers must retain adequate records to document the verification steps taken.
One certainty that did come out of today’s meeting, however, was a confirmation that an issuer needs only a “reasonable” belief that the investor was accredited rather than an “absolute” belief. All this means is that if you took reasonable steps and an investor lied about his accredited status, you would not lose the exemption eligibility. Finally, in an effort to detect fraud, the proposed rules modify Form D by requiring a new item for issuers to indicate whether general solicitation or advertising was used in the offering.
Because the Commission proposed rules rather than an “interim final rule” as the Commission had originally planned, the current rules prohibiting general solicitation still apply. Because of pressure from Congress and the two Republican appointees on the Commission, Gallagher and Paredes, the final rules probably will be acted on reasonably quickly after the 30 day comment period.