Crystal balling general solicitation

Coming up on two weeks since the SEC proposed rules to lift the ban on general solicitation in Rule 506 offerings.

As we get just a bit of distance from the day the proposal was published, it seems clearer that the SEC proposes to bifurcate Rule 506. The existing Rule 506 - private offerings that involve no general solicitation - would become new Rule 506(b); and the exemption that would apply to public offerings where only accredited investors may purchase, that would be new Rule 506(c). I say "would" rather than "will" because the rules are proposals yet, not final.

Small crystal ball

Though the future may involve more complexity than choosing one Rule 506 over the other.

Thoughtful lawyers are already predicting what the proposed rules will mean for the startup and emerging company financing ecosystem. I'll survey, by lawyer, some of the better forward-looking statements.

Matt Bartus

"With the amended rules," Matt Bartus writes on his blog, "the SEC effectively is removing the 'private' from 'private placements' and will open the door to broadly marketed, unregistered offerings and sales of securities, albeit in offerings limited to purchases by accredited investors."

Matt calls out the following "potential impacts," should the rules become final as proposed:

  • private companies and private funds will be able to advertise in any medium;
  • online platforms "will be further legitimized;" and
  • public companies will be able to widely market "private" placements, and may be able to conduct private and public offerings concurrently.

Dan Hansen

Dan Hansen's firm, Montgomery and Hansen, put out a memo to clients that I've linked to before. It remains the single best combination of summary and analysis I've seen, and would be a good resource for anyone considering commenting on the SEC release before the comment period ends this month.

Dan applauds the SEC for not mandating specific methods by which issuers must verify the accredited status of investors. But at the same time, he chides the Commission for not offering verification safe harbors. "Safe harbors are needed for companies to act with confidence out of the gate," he writes. "The uncertainty will lead to conservative behavior and additional cost and investor hassle. The SEC invited comment on this point and we suggest a response that specific safe harbors should be implemented for at least private company offerings."

Dan also deftly analyzes how a startup or emerging company may risk greater peril under Rule 506(c) from noncompliance, than it might under Rule 506(b):

"With current Rule 506, issuers can rely on a Section 4(a)(2) exemption as a backstop if the 506 conditions aren’t met. In the general solicitation context, however, there is no back stop. If an issuer blows 506(c), 4(a)(2) is not available and it’s arguably had a public offering. In addition, a blown 506(c) exemption could remove a funding platform’s broker-dealer exemption because that exemption under the JOBS Act requires the securities 'be offered and sold in compliance with Rule 506.' Thus the penalty for being wrong in the general solicitation context is far more significant than under current 506 . . ."

John Myer

Of all those criticizing the SEC for missing an opportunity with the general solicitation proposal, John Myer is the harshest. You will have noticed that in his comments on this blog, as well as his own post on the SEC release.

John also calls attention to possible problems in transitioning to a world where hedge funds advertise:

"One of the most startling implications of Section 201(b) of the JOBS Act is that hedge funds will be able to publicly solicit potential clients. To date, registered investment advisers who manage money through pooled funds have been unable to say anything about these products on their websites. Instead, their sites contain only contact information and a log-in link. Somehow, once the proposed rules go into effect, these sites will presumably light up and start soliciting investors. How the paradigm shift is to occur has been the subject of much discussion. In its release, the SEC simply confirmed the obvious, stating the belief that privately offered funds would be permitted to solicit and advertise under amended Rule 506 without losing their hedge fund exemptions. The North American Securities Administrators Association has been waiting for the SEC to take the lead regarding SEC registered investment advisers. NASAA doesn’t have much choice here, since Rule 506 pre-empts state regulation. But state regulators have jurisdiction over most newly formed hedge funds because they regulate investment advisers who manage up to $100 million in client funds (the larger funds fall under federal jurisdiction). Having fewer resources, the smaller and newer hedge funds are invariably going to have more issues in transition. Since the SEC totally avoided this subject in its release, perhaps the Commission is speaking to NASAA in private. I sure hope so."

Doug Cornelius

Doug Cornelius' invaluable blog is always up to the minute when compliance standards are in play. In addition to providing his own commentary, Doug can also be counted on for links to the newest primary and secondary materials.

And he's a blunt Disqus commentator. In comments on this blog last week, he predicts eventual backlash that will require new legislation. (Unlike many commentators, Doug doesn't slip into the habit of laying at the SEC's door full responsibility for regulations that implement Congressional mandates.)

Here's a Disqus thought from Doug about hedge fund advertising:

"I expect there will be some dramatic backlash after the general solicitation bad is lifted. Hedge funds are not subject to the same regulatory impositions of uniformity and clarity that exists in the mutual fund area. Retail investors will get hurt and new legislation or regulation will be imposed to try and fix the problem."

And some colorful commentary on the likely weakness of issuers that advertise the hardest:

"The companies most likely to engage in heavy advertising are not likely not going to be the best-performing, best run fund or private companies. I look at attorney advertising for comparison. It's not often you see an ad for Sullivan & Cromwell outside of a trade publication."

Photo: Scott Thomas / Flickr.

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