Washington Post article about the lost promise of new startup financing rules

Today's post is a re-posting of a comment I left yesterday on a Washington Post article by J. D. Harrison, entitled Can crowdfunding fill stock market’s ‘black hole’ for startups and small businesses? 

The article speaks broadly to the need startups and innovators have for capital, and how financial markets are no longer serving that essential function as they should. My comment isn't about crowdfunding, generally, but rather is pinpointing on one of several remarks made in the article by Mark Cuban. Overall, Cuban's points are terrific; but with regard to his comment on the burden of accredited investor verification under upcoming Rule 506(c) (to be effective on September 23), I think Cuban makes the same mistake most of us have, and is overreacting to that particular, Congressionally-mandated burden.

CaptureOne other prefatory comment, and this is an aside that may be gratuitous: it's a good thing that Jeff Bezos will soon own the Washington Post, because the current stewards of the site make it extremely painful and difficult to leave a comment. I probably spent more time trying to register to leave a comment, than I actually spent writing the comment - and even then I had problems getting the site to let me post. Gotta think Bezos will fix nonsense like that in a heartbeat.

Mark Cuban's comments are insightful and compelling - as his comments usually are. But I think he and most of us, frankly, are overstating the problem with the accredited investor verification requirement that was part-and-parcel of the lifting of the ban on general solicitation in Rule 506 offerings (now to be known as Rule 506(c); more on that below).

First of all, it was Congress, not the SEC, that determined that the tradeoff, for making it okay for startups and emerging companies to advertise within a 506 exemption, was to make it tougher to simply accept the investor's word that she is accredited. And when the SEC gave us all, in proposed rule form in August 2012, a rule set that basically said, go do what is reasonable in the circumstances, we all looked a gift horse in the mouth and demanded "safe harbors." And now we're complaining about those safe harbors. Thankfully, if you look closely at the final rules, I think you can fairly say that we still have the benefit of the flexible rule as first proposed. In other words, skip the safe harbors and go develop good industry practices for "verification" that do not involve the dissemination of PII to every garage startup with absolutely no ability to control and secure sensitive private information.

Second of all, the SEC had the foresight to leave the old rule set - Rule 506 without general solicitation - in place. The agency did not have to do this. So now we have two rules in parallel: the old 506, now to be called 506(b); and the new 506 under which you can advertise, as long as you take "reasonable steps to verify" your purchasers are accredited, christened as 506(c).

More troubling than the final rules lifting the ban on general solicitation - which again I think the agency did a good job of - are a set of proposed rules that would make it tougher to comply with 506(c) and would make 506(b) harder as well. The proposal is untimely. It will be tough enough to get used to 506(c) as Congress intended it.


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