Federal regulators recently announced the first of what could be many sweeping changes to the accessibility to capital by the business community. For 80 years, a general solicitation ban has been in place limiting the ways in which hedge funds, venture capitalists and startups could raise money, relying on word-of-mouth and private communication to generate interest in their investment opportunities. The changes set forth in rules adopted by the Securities and Exchange Commission (SEC) on July 10 will effectively allow companies to cast a much wider net to solicit investors by permitting public advertising of private placement opportunities.
Specifically, the SEC voted 4-1 in favor of implementing Section 201(a) of the Jumpstart Our Businesses (JOBS) Act, enacted in 2012. One of the six key tenets of the JOBS Act was to lift the 80-year ban on general solicitation for all private fundraising, which the SEC has now accomplished by making the following changes:
- Rule 506. Currently, companies trying to raise capital through the sale of securities must either register the offering with the SEC or rely on an exemption from such registration. Rule 506 of Regulation D from the SEC is the most widely used exemption from registration, addressing the way issuers raise funds through private offerings. The SEC’s changes to Rule 506 permit issuers to use general solicitation and general advertising to offer their securities for sale to accredited investors meeting certain income or net wealth requirements. Companies seeking private investors could issue press releases or leverage social networks, for example, to solicit capital.
- Form D. Form D, the notice submitted to the SEC by issuers selling securities under Regulation D has also been revised to add a new box to be checked if the issuer is relying on the new Rule 506 exemption permitting general solicitation.
- Rule 144A. The JOBS Act also directed the SEC to amend Rule 144A, an exemption governing the resale of securities to qualified institutional buyers (QIBs). Under the amended rule, securities sold pursuant to Rule 144A can be offered via general solicitation to potential investors, provided that the securities are sold only to persons reasonably believed to be a QIB.
These amendments will become effective in mid-September, and fundraisers will be able to engage in a general solicitation for a Rule 506 private placement commencing 15 days after the new Form D has been filed with the SEC. Upon finishing their solicitation, companies will then have 30 days to amend their Form D accordingly.
Will lifting the ban on general solicitation mean we’ll suddenly be inundated with ads for hedge fund investments? Not likely. Revised Rule 506 doesn’t thrust Joe the Plumber into an investment feeding frenzy. In an effort to reduce risk to unsophisticated investors, the SEC kept certain other provisions of Rule 506 in place, such as the requirement that all purchasers of securities pursuant to the new rule are accredited investors.
Not everyone, however – including one of the five commissioners overseeing the SEC – believes that the safeguards implemented by the SEC will provide adequate protections to investors. Many believe that the requirement for investors to be accredited is a far cry from ensuring that such investors are sophisticated enough to understand and undertake the risks of investing, making them easy targets for companies looking to take their money. And it’s a lot of money: $900 billion was raised in 2012 for unregistered securities under Rule 506 and Regulation D, according to the Wall Street Journal – significantly more than the $43 billion raised in that year’s IPOs.
Opponents of the new SEC rule revision will likely be even more pessimistic as further provisions of the JOBS Act are debated and implemented by the SEC, including the CROWDFUND provision, which the SEC is currently considering. If the SEC ultimately adopts the rules to implement crowdfunding – where unaccredited individuals (such as Joe the Plumber) can invest directly in hot new startups – we will likely see an even greater influx of capital into the markets. The greatest gains may be in the technology startup ecosystem, which has seen a significant recent resurgence of momentum since the 2001 dotcom crash.
The changes enacted by the JOBS Act and currently being implemented by the SEC have generated an intriguing alternative to an IPO, a capital-raising strategy that many companies are hesitant to undertake for fear of losing control of their company and being hamstrung by stringent reporting requirements. Thanks to the SEC’s relaxation of the ban on general solicitation, we are seeing a bridge between, or hybrid of, the prior private placement model (which, due to the ban, was relatively limited in scope) and the IPO. Companies now have the option to reach a significantly larger pool of investors (akin to an IPO) while still maintaining the governance and reporting benefits of a private placement.
For better or for worse, these new changes mean we can look ahead to increased investor awareness of opportunities, as well as increased questions from companies struggling to ensure compliance with SEC requirements in this burgeoning area of capital funding.
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