Angel Capital Association weighs in on SEC proposed rule on general solicitation and accredited investor verification

The Angel Capital Association has submitted a comment letter to the SEC on the rule the Commission has proposed to implement Section 201(a) of the JOBS Act.

You'll recall that, among other things, the JOBS Act mandated that the prohibition on general solicitation and general advertising in Rule 506 offerings under Regulation D should be lifted and no longer apply, provided that all purchasers in the offering be accredited investors. Out of a concern that advertised offerings could generate more hype, Congress instructed the SEC to come up with "methods" by which issuers should "verify" the accredited status of the purchasers of its securities.

(Note: we are not talking about equity crowdfunding here. We are talking about a reform to the rule that governs the way most startups and emerging companies raise private money in the United States today. Essentially, we are talking about angel and venture capital fund investing.)

Screenshot of ACA letterThe Angel Capital Association's letter, written by its Executive Director, Marianne Hudson, expresses agreement with the SEC's position that the current Rule 506 be preserved as an option for issuers and their investors. The SEC proposed to codify this "quiet 506" (Joe Bartlett's term) as newly enumerated Rule 506(b). Assuming final rules are issued in the form currently proposed by the SEC, startups and emerging companies could conduct exempt offerings under Rule 506(b) and not face any new burden of "verification" of the accredited status of its investors. (Of course, issuers relying on Rule 506(b) would not be able to generally advertise or generally solicit, either. And they would have to follow the same practices used today for vetting investors' accredited status.)

As for issuers that do choose to engage in general solicitation or general advertising, the SEC has proposed a new Rule 506(c). Startups and emerging companies relying on Rule 506(c) (assuming the same is finalized as currently proposed) would have to take "reasonable steps to verify" the accredited status of its purchasers, and no non-accredited investors could purchase securities.

The most controversial aspect of the SEC's proposal has been its lack of any definitive safe harbor by which an issuer can be certain it has satisfied the amorphous "reasonable steps" standard of proposed Rule 506(c).

In its letter, the Angel Capital Association concurs with the SEC's judgment that leaving "reasonable steps" as an open standard "allows for advancements in verification methods over time."

However - and here we get to the thrust of the ACA letter - the Angel Capital Association believes that "safe harbors," categorical methods of verification that an issuer can have confidence in following, should be provided for "noisy" (Bartlett again) Rule 506(c) offerings that involve natural persons, that is, individual angel investors.

Here's a key quote from the ACA letter:

"Safe harbors are needed for companies and investors to act with confidence. Without safe harbors for 506(c) offerings, issuers won’t know when they’ve done enough to satisfy the 'reasonable steps' test. Issuers and investors will not be clear on liabilities or how rules will be enforced. This uncertainty will lead to conservative behavior. Many of our members tell us that, faced with concerns about liability, cost, or complexity in implementing the rules, they will limit their pace of investment in these offerings until the market sorts out the rules."

The ACA is not the only organization asking the SEC to come up with safe harbors or officially approved methods of accredited investor verification. If the SEC heeds the comments, we may see another proposed rule, and the lifting of the ban on general solicitation may be further delayed.

Disclosure: I serve on the Advisory Council to the ACA Public Policy Committee. The views I express on this blog are always my own.

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