The chilling effect of accredited investor verificationBy http://profile.typepad.com/1237764140s22740 // July 11, 2012 in Accredited Investor Definition, General Solicitation, JOBS Act, Reg D
I got an email yesterday from a reader who is viewing me as too willing to accept the concept that accredited investor status should be "verified."
He stated his concern succinctly:
" . . . I don't understand why you are so willing to accept the notion that a heightened standard of verification is a good thing? . . . you must realize that verification will have a chilling effect on angel investment, which, in turn, is contrary to the spirit of the legislation. Who wants to turn over tax returns or brokerage statements?"
I don't disagree. Many angels I've talked to have expressed similar concerns.
Some are adamant that they will not share their tax returns with a three-person startup in a garage. Others are more receptive to permitting their brokers to serve as a third party "verifier," where the fact of verification, but not the underlying records on which the verification is based, are shared with the issuer.
I think what may be happening - why this loyal reader may be picking up a vibe that I'm not opposed to all heightened verification - is that I'm taking for granted that the current paradigm will remain as an alternative. That is to say, for issuers who do NOT engage in general solicitation or general advertising (presumptively, the entire universe of Rule 506 deals today), the current practice of reasonable reliance on investor representations will continue to pass muster.
Maybe I shouldn't be taking that for granted! I could be in for a big disappointment, should the proposed rules, when published, not, in fact, restrict the heightened verification process to Rule 506 deals that involve general solicitation or general advertising.
I'm reading the SEC as "getting" the congressional quid pro quo here: heightened verification is the price to pay for targeting a broader audience (or perhaps it would draw the distinction better to say, for failing to target or discriminate at all).
Here's the problem with opposing heightened verification altogether: the JOBS Act clearly contemplates that issuers must do something more to ensure that all the investors in a deal are accredited, when the deal has been broadcast publicly. So the SEC is going to have to reflect this legislative imperative in its rules. I've accepted that reality, and put all my eggs in the basket of hoping that it will remain possible to conduct Rule 506 offerings as before - without general solicitation and without advertising.
Now, as soon as I say that, I start to feel tension between the two parallel universes. Didn't the reform to Rule 506 start out, at least in part, to "cure" the arguable noncompliance, around the edges, of the current practices of public pitch meetings, incubator contests, tweeting, etc.? Of course it did. That is the principal reason many of us hailed it when it was first proposed.
Even entrepreneurs and angels who today believe they will not participate in deals involving general solicitation or general advertising will, at some point, find the old paradigm to have been impacted. There could be less of a regulatory willingness to overlook technical noncompliance with the prohibition on general solicitation, should the new 506 take hold and become viable.
Photo: "Chill effect at Times Square" by Johan Lange / Flickr.