Want to Avoid "General Solicitation?" Focus on Relationships!

The following is adapted from remarks prepared for the Angel Capital Association's 2015 Angel Insights Exchange, held in New Orleans the week of November 9. I am the volunteer chair of an advisory council to the ACA, but the views I express below are personal to me, and not a reflection of ACA views or policy; nor are they a reflection of views of my law firm.

As we all know, Dodd-Frank (2010) and the JOBS Act (2012) brought big changes to the rules that govern what’s okay and what’s not okay in the world of federal exemptions from securities registration requirements.

Couple-by-Paul-Kline-Creative-CommonsOne of the biggest reforms – permitting startups and other private companies to advertise a securities offering, provided that all purchasers are accredited investors – has caused the most consternation, at least in the early implementation. That’s largely because this particular reform – “lifting the ban on general solicitation” in Rule 506, the primary federal exemption on which almost all angel-backed companies rely – came with a catch. The catch is this: if you advertise or otherwise “generally solicit,” you will have a newly-invented1 and heightened burden to verify the accredited investor status of your purchasers.

This has caused many entrepreneurs and angels to shun Rule 506(c). Because the new rules made clear that the old rule (now called Rule 506(b)) remains available on a parallel track, you can still raise your money privately the old way; the heightened verification burden will not apply.2

But still there are gray areas: what about demo days; what about online platforms that restrict access so that only accredited investors can see deals; what about angels syndicating deals with other angels? In the early days of implementation of these reforms, people are worried – even more than they were before the JOBS Act, it seems3 – on whether they might trip accidently into conduct that could be deemed “general solicitation.”

Thankfully, we’ve had new guidance from the SEC this year pertinent to the quandary of “general solicitation” and what we might call the 506(b)/506(c) divide. 2015 has brought us:

  • No fewer than eleven (11) new questions-and-answers on general solicitation, to be added to the Division of Corporation Finance’s ongoing Compliance and Disclosure Interpretations; and
  • A new “No Action” letter, called “Citizen VC,” which tells an online platform how it might avoid slipping into Rule 506(c) territory.

The theme of the new SEC guidance is this: a “pre-existing, substantive relationship” can be a terrific antidote to the virus4 of “general solicitation.”

Now, the concept of the pre-existing, substantive business relationship has been around for a long time. It’s been a way of demonstrating that a given deal is indeed private, and prior guidance from the SEC has long held that an issuer can extend the utility of the concept by including, not only persons the issuer knows, but also the relationships of a broker dealer participating in a given offering.

The new SEC guidance, however, now makes it expressly clear that it’s more than okay for an issuer to be introduced by an angel to other angels the issuer might be meeting for the first time, without tripping into “general solicitation.”5 Here’s an excerpt from the answer to Question 256.27:

[W]e acknowledge that groups of experienced, sophisticated investors, such as “angel investors,” share information about offerings through their network and members . . . may introduce [the] issuer to other members. Issuers . . . may be able to rely on those members’ network to establish a reasonable belief that other offerees in the network have the necessary financial experience and sophistication.

Similarly, the new SEC guidance at Question 256.33 states that demo days can be “insulated” by the pre-existing, substantive relationships that a demo day organizer has with attendees:

Where a presentation by the issuer involves an offer of a security, the presentation at a demo day or venture fair may not constitute a general solicitation if, for example, attendance at the demo day or venture fair is limited to persons with whom the issuer or the organizer of the event has a pre-existing, substantive relationship or have been contacted through an informal, personal network [of angels] as described in Question 256.27.

Finally, I want to highlight the Citizen VC No Action Letter, because it speaks to what an online angel investing platform might do, should it wish to remain under the ambit of Rule 506(b). Here’s how Dan DeWolfe, a member of the ACA Advisory Council and the attorney who wrote the no-action request on behalf of Citizen VC, summarized in a blog post (co-written with Samuel Asher Effron) his take on the import of this particular guidance:

In essence, the approach under the CVC Letter is to make the online private placement offering similar in policies and procedures to an offline private placement. The pre-existing relationship is not time based nor is it satisfied by answering a mere two questions. Rather, the establishment of a pre-existing relationship depends on the QUALITY of the relationship between the issuer and a potential investor. While the vast majority of online offerings will clearly fall within the new Rule 506(c), the CVC Letter does spell out a way to conduct a true private placement in a password protected web page that does not give rise to a general solicitation.

How can an online platform be sure it is not using general solicitation? That’s right, the answer is in line with the guidance theme for 2015: establish a substantive, pre-existing relationship with prospective investors. In the case of online platforms, establishing such a relationship must occur prior to, and not in the context of, a given offering by an issuer on the platform.

Photo credit: Paul Kline (Creative Commons)

<id="fn1">1. On the “newly invented” nature of the verification burden imposed by offerings that are generally solicited pursuant to new Rule 506(c): many securities lawyers might emphasize that Rule 506 has always, always required an issuer to have a reasonable basis on which to conclude that its purchasers were accredited. I myself predict that the distinctions between 506(b) and 506(c), on the point of verification, will inevitably blur over time. But it is certainly fair to say that current industry practices that pass muster as sufficient under 506(b) do not pass muster under 506(c).

<id="fn2">2. It’s fair, and probably important, to point out that the verification pitfall is connected with another aspect of Rule 506(c) that is scary to startup and emerging company lawyers, and should be to entrepreneurs and angels as well: if you’re relying on an exemption that expressly stipulates that you have engaged in general solicitation, then, unlike what would be typical in most Rule 506(b) offerings, you will not have other private offering exemptions to fall back on, should your Rule 506 exemption somehow fail. Claiming exemption under 506(c) is like walking a highwire without a net.

<id="fn2"><id="fn3">3. Anxiety about the meaning of “general solicitation” dates back to the rollout of Rule 506(c) two years ago. See this piece I wrote for the Wall Street Journal: http://blogs.wsj.com/accelerators/2013/09/27/weekend-read-the-trojan-horse-of-accredited-investor-verification/.

<id="fn4">4. Is my metaphor over the top, or is it really dangerous and unhealthy for a startup to conduct a Rule 506(c) offering? This is a question I would like to put back to all of you!

<id="fn5">5. Technically speaking, it does not appear as though the new guidance is saying that a given angel’s network extends the reach of the issuer’s pre-existing, substantive relationships, at least not in the same way that a broker-dealer’s relationships might. See Question 256.29. Rather, the long-standing practice of introductions via angel networks appears to be a similar but independent method of “neutralizing” general solicitation.

First Cherry Blossom

Wet and temperate in Seattle this morning.

And look, Spring!

First Cherry Blossom

Lark & Environs

Interesting stuff going on at, let's call it 10th and Seneca, about a half block east of Broadway off Madison.

Lark has recently moved there, and, based on one dinner experience at the new location, is as good or better than ever.

There are also different spaces, and different branded food experiences, built into the lofys and crannies of the old industrial warehouse. One is called "Slab," and it will serve sandwiches from 10 to 3. Including what the menu describes as a 12 hour brisket!

All this not a stone's throw from middle-America chains like Silver Cloud and IHOP.

Lark & Environs

One Thousand Things Worth Knowing

This weekend I've read Paul Muldoon's newly published collection of poems, "One Thousand Things Worth Knowing." (The dust jacket sports a very pleasing design by the ubiquitous Quemadura, a brilliant designer and a kind man I will never forget for how he helped me during a brief turn I took as a publisher.)

I say I've read the book, present perfect, but I'm still reading it by way of re-reading it. Muldoon is new to me, and I don't yet find familiar his poetics or his themes.

His strangeness, to me, derives from his different commitments, you might say.

For instance, he utilizes the sonnet and other traditional stanzas with end rhymes (or slant rhymes; that itself is not unfamiliar); but his lines most often aren't in a regular meter, or at least not in a consistent pattern of feet.

Sometimes the effect (of what I might call free verse wrapped around visually recognizable stanzas and traditional rhyme schemes) is like that of a planet nearing the sun, utilizing the acceleration of gravity to whip itself around the star and propel itself away.

The density and earthiness of Muldoon's diction seems very much of a well-established, modern, Irish tradition, recognizable as the idiom of Seamus Heaney, not least of all when the poems allude to The Troubles and growing up in Ireland.

But Muldoon is an American as well. A verse in this book is just as apt to traverse the Civil War or the Southwest as Ireland or England or Viking invasions.

The best example I am able to give you – I'm not suggesting this is one of the finer poems in the book, just that it illustrates what I am currently able to describe - is a poem in the middle of the book called, "Some Pitfalls and How to Avoid Them," about the party of Lewis and Clark and their reliance on mercury-laden laxatives. Here is an excerpt, most of the final three stanzas:

"... Who would have guessed
that J.M.W. Turner was perfecting in his ability to scumble
cumulonimbus and stratocumulus
precisely as Lewis and Clark reached the Pacific coast

"And build Fort Clatsop? The Cheyenne chewed the gum
of both ponderosa
and lodgepole pines. Bear in mind how our fireside banter
may be lost to the generations to come

"but their native scouts
will still be able to follow our route across America
by the traces of mercury
in our scats."

You see what I mean. Stanzas of four lines in an ABBA in a rhyme or slant rhyme pattern; references to the exploration of the Pacific Northwest and to the most famous British landscape painter of the time.

Photo from a tweet by The Irish Times.

One Thousand Things Worth Knowing

ACA Webinar on Accredited Investor Definition and Established Angel Group Certification

I've just listened to an archived recording of an excellent webinar presented by the Angel Capital Association last week (I had intended to listen in real time, but got pulled away): ACA Webinar on Accredited Investor Definition and Established Angel Group Certification.

Presented by ACA Executive Director Marianne Hudson and ACA Chair David Verrill, the hour long webcast covers how the accredited investor definition might change (and how that might impact the startup investing ecosystem) and what the Angel Capital Association is doing to facilitate the transition to the brave new world of general solicitation.

The chief initiative of the ACA is the "Established Angel Group" certification program, which is designed to help issuers implement the "principles based method" in satisfying the heightened accredited investor verification burden under new Reg D Rule 506(c) (which allows general solicitation). The Established Angel Group (or "EAG") certification program has potentially broader implications as well - for instance, if the accredited investor definition changes to put more weight on, or define an alternative path to accreditation based on, investor sophistication, the EAG could be important for purposes of both Rule 506(b) and Rule 506(c).

Inside baseball stuff, I know, but if you're interested in the history of how it came to be that only high net worth people were allowed to invest in startups, how that situation was seemingly democratized (somewhat) by the 2012 JOBS Act, and the rearguard action of state securities administrators and others to put a lid on the reforms, giving an hour of your time to this webinar will help fill you in.

A Sestina About Copyright

Last week Boing Boing published a sestina I wrote earlier this year on the subject of copyright.

I'm thrilled about this and hope you will check it out: http://boingboing.net/2014/10/30/copyright-redux.html.

626px-Sestina_system_alt.svgWhat is a sestina? It is a verse form involving a patterned repetition of the same six words. This chart, credited on Wikipedia to Phil Wink, explains the pattern.

As you can imagine, the sestina as a structure requires copying; as a poetic practice, it demands of the practitioner the audacity to remix and engage in transformative use in transparent ways.

Sestinas are all about copyright!

Alan Bennett's anthology of six English poets

Thanks to a London nephew, I'm reading Six Poets: Hardy to Larkin, an anthology of poems by Hardy, Housman, Betjeman, Auden, MacNeice and Larkin, chosen by the English playwright Alan Bennett, with commentary by Bennett between each presented verse.

6a01156e3d83cb970c01b7c6fabe8a970b-580wiThe commentary is more about the disposition of the poets and their subject matter, rather than the art of their verse. But it's breezy and entertaining, and interesting to try to situate the six poets Bennett chooses with one another as a group.

Bennett's critical method is to end-run the cultivated pretensions of each.

For instance, speaking of A. E. Housman and his preoccupation with death in English colonial wars, Bennet writes:

"When the Great War came, and hundreds of thousands of young men died in battle, it might be thought that Housman would have been particularly affected. In fact, he appears not to have been, and this seems shocking. But poets are not statisticians; to them, one death means more than a thousand. When men are dying like flies, that is what they are dying like."

Of Betjman, Bennet praises "his marvelous ear for language." But the praise is qualified. "It's the limited language of the middle class, or of those aspiring to be so, but he was a master of it."

A very English book. I see that the content relates back to a Channel 4 television programme from the 90s! Still I feel well ahead of things, reading this in the fall of 2014, rather than the spring 2015 publication date set in the US.