On the same day that the SEC proposed rules that may make capital raising easier for companies by repealing the ban on general solicitation for private offerings, the SEC also proposed rules that may make it much more difficult to raise capital. Why would they do this? The repeal on the ban on general solicitation was required by the JOBS Act, but there is a lot of concern about fraud without the ban in place. And while the SEC’s mission is to maintain fair, orderly, and efficient markets and facilitate capital formation, the SEC has a third mission: to protect investors.
Here is a highlight (or a lowlight depending on your perspective) of what is being proposed:
- Require the filing of a Form D at least 15 calendar days in advance of using any general solicitation (rather than the current requirement of 15 calendar days after the first sale of securities);
- Require the filing of a “closing amendment” to Form D within 30 calendar days after the termination of an offering (there is no current requirement to file a final amendment);
- Increase the amount of information gathered by Form D such as the number of investors in the offering and the type of general solicitation used in the offering;
- Automatically disqualify an issuer from using Regulation D for one year if the issuer failed to file a Form D (currently no such harsh consequences);
- Mandate certain legends on all written general solicitation materials; and
- Require the filing of general solicitation materials with the SEC (temporary rule for two years)
Now, while these are still only proposed rules and the comment period continues through November 4, 2013, there has been a huge outcry from the startup community. Critics of these proposed rules that I have spoken to generally believe that the proposed rules are unworkable in the context of startup companies and will severely inhibit capital raising. In fact, most of the comment letters on the proposal express similar concerns.
And while I am against regulation just for the sake of regulation, I am not as incensed by the proposed rules as others. I think we need to all be concerned about the impact of fraud on the viability of Regulation D. In other words, as soon as the elderly widow loses her retirement savings due to a fraudulent securities offering, the whole idea of Regulation D becomes tainted in some way. Thus, to the extent that these proposed rules can prevent fraud, I think the rules are actually helpful for companies looking to raise capital. Of course, the biggest problem with my own argument is that I don’t think any of the proposals will actually deter or prevent fraud. Those who commit securities fraud will not be deterred by the need to file a Form D.
So, where does that leave us? I agree with the many commentators that the rule, as proposed, is unworkable in the context of the startup community. Startups will run afoul of the advance Form D filing as a matter of course. Hopefully, the SEC will reflect on the comments that they have received and seriously consider tweaking the proposal to align better with the realities of the startup community, while at the same time protecting investors. Ultimately, vigorous enforcement and harsher penalties on people who commit fraud strikes the best balance between deterring fraud and protecting investors.