~ "We don't want the Shamwow guy on TV hawking securities"
— Steven Bochner, WSGR attorney
Yesterday I posted on the WSGR seminar about the JOBS Act, which was characterized (correctly I think) as primarily about creating an easier on-ramp for "emerging growth companies" to get to a public offering (IPO).
Today I'm posting about the "bolted-on" parts of the Act pertaining to public solicitation and crowd-funded investment. While the idea of these things might sound good, the reality, as enshrined in the Act, is unlikely to match anyone's hopeful expectations.
A bit of background on the equity-funding of startups: In general, any company wanting to sell stock must first file a registration statement with the federal government (Securities and Exchange Commission, SEC) and with the various regulatory offices in each state government where they intend to offer stock. The time and expense of preparing these registration statements is enormous, however, so virtually all startups rely on one of several exemptions to registration. The best-known and most heavily used is referred to as Regulation D, which includes three slightly different variations known by their section numbers: 504, 505 and 506. The specifics vary, but all prohibit "general solicitation"—you cannot use these exemptions if you advertise or otherwise proffer your stock to the public at large.
The JOBS Act appears to remove that restriction, but the details are murky because the SEC has not yet issued the rules and regulations called for by the Act. They are nominally required to do so by July, but the SEC is way behind on the issuance of such things, and the consensus was that it would likely take much longer. For now, companies seeking funds should continue as they always have, and not make use of (or assumptions about) these elements of the Act.
Meanwhile, this is what we know (and don't know):
- The Act does not allow entrepreneurs directly to solicit investment from the public. Putting an advertisement on your web site's home page or blasting out over Twitter will still violate the Regulation D exemption. What public solicitation the Act allows must be done through a registered portal or broker/dealers that are pre-approved by the SEC. (These and other restrictions to Title III were mostly added by the Senate at the last minute, so the legislative intent is unclear. That's why we all must wait for the SEC to promulgate rules.)
- Publicly solicited investors must be accredited, i.e. such investors must meet minimum thresholds of income and/or net worth. It will be difficult for portals to comply; will they rely on representations from the investors themselves? How will this be policed?
- The changes to Section 506 will probably have an impact on the rules that allow different offerings over time by the same issuer and how they are treated. These questions of integration of offerings can be rather technical, but it is another area where entrepreneurs seeking funding will not have a truly free hand to go solicit investors, but must instead wade deeply into legal technicalities with their attorneys.
- Entrepreneurs will be required to provide the income tax returns and financials of the company seeking funding. The requirements get stiffer as the amount of money sought increases. At $500K and above, companies must provide audited financial statements, a substantial burden of time and expense that few entrepreneurs are willing to undertake. The value of a Section 506 Regulation D exemption mostly disappears.
WSGR attorney Todd Carpenter noted that "the goal of regulators to look at, update and liberalize markets is a step in the right direction," while Steven Bochner worried that we may yet see "a thousand Bernie Madoffs flourish." The panel agreed that to the extent that fraud rises as a result of these changes we'll certainly see a regulatory roll-back in future. While many protections still exist, the challenge is to reduce regulatory burdens at this "tender stage" of companies' development without causing new problems.
President Obama, in signing the Act said that "we'll be watching very closely." Let's hope so.