William Carleton, Counselor @ Law

Whither general solicitation?

Title II of the JOBS Act called upon the SEC to implement rules lifting the ban on general solicitation in Rule 506 offerings, where all purchasers are limited to accredited investors.

This might have been a relatively straightforward instruction, except that Congress also required that the implementing rules must somehow call on issuers to "verify" the accredited status of the purchasers. While at the time no one actually said or intimated that the industry has seen widespread cheating to get around the accredited investor standard - verification was not a concern when the standard was modified by Dodd-Frank a few years back - several floated a vague presumption that went unchallenged: if issuers are tweeting broadly for angel investors, non-accrediteds will get caught up in the hype and lie, or issuers will be somehow inclined to look the other way, even though they didn't when 506 was "quiet."

In practice, of course, the rule against general solicitation had already been bent back so far, it might fairly have been said to already be standing on its head.

One can imagine, with the FundersClub and AngelList no-action letters showing a model that other accredited crowdfunding platforms might follow, that the formal lifting of the ban on general solicitation might never be relevant: those no-action letters don't discuss general solicitation or accredited investor verification. It's as those the SEC staff assumed the entire discussion was taking place under Rule 506(b).

But other portals for accredited investors will want the ban to be formally lifted as the JOBS Act requires. These will be the angel platforms for which it will make sense to rely on Section 201(c) of the JOBS Act, an exemption from federal broker dealer registration requirements that say it's okay, when dealing only with accrediteds, to generally solicit, transact, co-invest and more. Though this section of the JOBS Act has already found its way into the US Code and has in fact been law since the President signed the bill, the way the law is worded, and the unfortunate SEC staff FAQ about Section 201(c), make it important that the ban be formally lifted. Right now, at least on division of SEC staff would appear to take the position that, while angel platforms can do all the things contemplated by Section 201(c), no issuer could actually participate, lest it violate the ban on general solicitation.

It would seem that angel platforms relying on Section 201(c) will be buying into the "noisy" 506.

Anyway, this recap this morning prompted by the item on Broc Romanek's Corporate Counsel blog this morning, assessing conflicting signs on what new SEC Chair Mary Jo White might do about the stalled out rulemaking on the lifting of the general solicitation ban. Might the new Chair be pushing for adoption of the rules proposed in August as interim final rules, as Bloomberg reports? Hard to say.

Side note and prediction: all the attention on general solicitation and verification will put increased pressure on the accredited investor definition itself. Accredited crowdfunding - whether pursuing the models blessed by the no-action letters or relying on Section 201(c) of the JOBS Act - will in fact be hampered in a big way if regulators find a way to narrow the pool of those who qualify as accredited.

Photo: "General Sir Henry Rawlinson (left) chats with a French War Correspondent," National Library of Scotland's Flickr photostream.

Crowds of angels

I'm giving a talk later this morning for the Seattle Angel Conference. The topic is "Crowdfunding, AngelList, and angel investors: The Venn of it all."

Preparing for it yesterday, I put together this webpage. It will be my working outline for what I want to say in the "presentation" portion of my talk; and I think it will be a good resource for the workshop or Q&A portion of the meeting.

I am determined to never again present from a PowerPoint slide deck.

Microsoft's influence on how we work and think will resonate for a long time. Indeed, as I cull the Apple machines out of my life and return to PCs, I realize that in large part what's happening is the office worker training I received 20 years ago is reasserting itself. But PowerPoint is really a fad has passed. I don't know what the new fad is - Ted talks? (God help us.)

Anyway, check out that webpage. I think you'll pick up readily on the themes I hope to cover.

I'll report back.

Image: Rakka / Flickr.

Trying to make sense of an SEC staff FAQ

Turning back for a moment to the recent SEC staff FAQ, published on the SEC site earlier this month, which purports to interpret the federal broker-dealer registration exemption for angel groups and angel platforms that is a feature of last year's JOBS Act:

How is it that the staff conclude that Congress meant the exemption to be essentially worthless, unlikely to be available to anyone "outside the venture capital area?"

We don't have answers yet, but it occurs to me that we need to get grounded again in what was said on the House floor at the time that the exemption was introduced. The exemption took the form of an amendment to Title II, the provision of the JOBS Act that also contains the mandate that the SEC lift the ban on general solicitation in offerings limited to purchasers who are verified as accredited.

The introduction of the amendment, by Patrick McHenry of North Carolina, was a love fest. Barney Frank rose to support it and labeled it non-controversial. Here's a link to a pdf of two telling pages from the March 8, 2012 Congressional Record. And here's a key excerpt, the speaker being Representative McHenry:

"It takes away some red tape that is within securities regulations, and it allows incubators, forums, and online platforms which only connect accredited investors to start-ups to be exempt from SEC registration as a broker-dealer if they, number one, do not charge a commission or fee for their service; number two, do not handle the moneys of investors; and, number three, only permit accredited investors to use their platforms.

"This is a very narrow amendment, very specifically crafted. In fact, the President’s Council on Jobs and Competitiveness in October of last year said in their report that the emergence of angel investors and networks have also played a crucial role in initial funding of companies, and that the council recommends that clarifying that experience and active seed in angel investors and their meeting venues should not be subject to the regulations that were designed to protect inexperienced investors."

Further context:

• The SEC staff's Frequently Asked Questions About the Exemption from Broker-Dealer Registration in Title II of the JOBS Act; and
• this blog's first post on the topic, Speed bump for online angel platforms.

Photo: Neil Harvey / Flickr.

Midweek pivot

As promised yesterday, I do have a followup post in mind on the subject of legislative definitions of social media.

When they turned in their grades, both Venkat Balasubramani and Kyle Hulten offered their own draft definitions. I want to post those definitions, along with grades and comments from Doug Cornelius that arrived as the first post went to press.

But today feels like a time to cut back to the other topic we were covering this past weekend, the question of when the SEC might get around to finishing what it started in August when it released rules to implement the lifting of the ban on general solicitation and general advertising in Rule 506 offerings.

The SEC should follow through. Not simply because they have missed the Congressional deadline for doing so. (As Doug, Joe Wallin and I have stated at different junctures, Congress could have amended the rule itself by legislation, as it did the accredited investor definition when it put Dodd-Frank together.) No, the real reason the SEC should act is that the industry needs the guidance. Inaction leaves the good guys in limbo and gives the bad actors ever more increasing sway.

Here's where we stand today on the story:

• On Saturday, I wrote a post suggesting that the new SEC Chair, Elisse Walter, may have a different agenda for the rules that implement the lifting of the ban on general solicitation, an agenda that could involve more than simply implementing the ban. I hope I am wrong about that, but the fears arise out of statements she made back in August when the rules were proposed (for which proposed rules she did in fact vote affirmatively).
• Also on Saturday, and remarked upon by me in this blog on Sunday, Joe Bartlett ran a post in VC Experts calling out how the old 506, the existing rule still in place and still at least nominally banning the use of general solicitation and general advertising, is being end-run, you might say (if you were inclined to eschew euphemisms). Joe's analysis suggests the real regulatory action of moment will be other than with implementing a new 506(c), overtly permitting general solicitation.
• And then yesterday, Doug Cornelius ran a post on his Compliance Building blog, Crowdfunding and the Ban on General Solicitation, that concludes with the prediction that that the SEC isn't likely to finalize the general solicitation rule for some time, at least not until a new Commissioner is appointed to fill Mary Schapiro's seat. Doug is making that forecast by counting the votes.

So there we are. More to come; we may have to hurry up and wait.

Photo: John Martinez Pavliga / Flickr.

More on where we are with general solicitation

Following up on yesterday's post: be sure to read Joe Bartlett's new post on VC Experts, QUIET 506.

Joe's provocative take is that it almost doesn't matter whether the SEC moves on 506(c). (Translation for those who haven't memorized the shorthand references: it almost doesn't matter whether the SEC finalizes rules, as required under the JOBS Act, to permit startups to advertise for angel investors.)

I may be exaggerating Joe's view, but only slightly:

"The fact . . . is that the ban [on general solicitation and general advertising] has been, as a practical matter, history for a number of years by virtue of the Two-Step process. Quiet 506(b) is in fact a very noisy Rule 506 in the real world and platforms such as AngelList, Circle Up, and others are already taking advantage of the internet to raise capital for emerging growth companies … and have been for some time. The advent of the Title II Regs, in that sense, is anti-climactic. We are already there, courtesy of the internet, and the trick now is to adjust to the new reality in the legal sense of the word."

What is the "Two-Step process?" See Joe's post for the explanation. In a word, it's a process that SecondMarket and others follow in making deals accessible to accredited investors, a process designed to fit within the contours of SEC letter rulings.

Not that Joe is saying all new regulation will be superfluous.

New regulatory initiatives will matter and are coming; it's simply that the efforts of consequence will focus on broker-dealer and investment advisor-like activity, not the patterns of general solicitation, as such.

Joe alludes to renewed vitality among state securities regulators. I'd like to know more about what he knows on this subject.

Finally, Joe tells a great anecdote at the end of this post. It's a funny story and Joe spins it with the suitable distance of the ironist:

" . . . [A] knowledgeable observer and I were discussing the impact of this incoming tide [of crowdfunding platforms] and I remarked that the elite investors, in their own minds, would likely find sourcing deal flow online as 'undignified.' He laughed and responded that 10 or so years ago, the maxim was that looking for spouses through online dating services was undignified. Now, he claims, everyone over 30 uses these platforms."

Looking back at views previously expressed by the new SEC Chair on general solicitation

Does anybody know when the SEC will again move on general solicitation?

I went back and looked at the statement then Commissioner, now Chair, Elisse Walter issued when the proposed rules were released in August. Here's an annotated version.

Troublesome stuff in there, including the explosive idea that implementing the lifting of the ban on general solicitation is a good time to revisit the accredited investor definition (not sure the Commission has latitude to revisit the net worth prong, not yet, but maybe it does to revisit the income thresholds)!

I think Walter is saying the following should be part of any rule to implement the JOBS Act-mandated lifting of the ban on general solicitation in Rule 506 offerings where all investors must be verified as accredited (the "noisy" 506, as Joe Bartlett says, or "506(c)" in the nomenclature of the August 2012 proposed rules):

• Filing a Form D should be a condition of the exemption;
• The filing should be made in advance of sales; and
• The Form D should gather additional (unspecified) information.

Under 506 today - which of course does not permit general solicitation - there is no pre-sale filing requirement. If pre-sale Form D notice filings are going to be required, hopefully this will only apply to Rule 506 offerings that involve general solicitation.

Don't know how to weigh Walter's reference to the accredited investor definition. Hopefully that is an idle remark and not a fight we'll have to go through to get the lifting of the ban on general solicitation implemented.

Here's another thought about dealing with the delay: the Congress could mandate that the rules proposed by the SEC back in August should immediately be deemed interim final rules. pending further rulemaking, whenever the agency got around to it. Or the SEC itself of its own volition could take the same action.

I think Gary Jay Brooks was right when he said the other day in the comments - albeit in a different context - that regulatory limbo isn't good. Gary's comment in part:

"I see no framework. I see people worried and confused. It's so elegant for the government to leave us entrepreneurs with a pile of shit policy and nobody to pickup the ball and run with a vision."

Photo: Erik Fitzpatrick / Flickr.

Rep. Patrick McHenry's parting shot at SEC Chair Mary Schapiro

My thanks to Gary Jay Brooks for alerting me to the development that is the subject of this post.

By letter dated November 30, Representative Patrick McHenry, writing in his capacity as chair of a Congressional subcommittee, chastises outgoing SEC Chair Mary Schapiro for foot-dragging on rules to implement the lifting of the ban on general solicitation in Rule 506 offerings, as required under Section 201 of the JOBS Act.

This is not the first time Rep. McHenry has had harsh words for Chair Schapiro vis a vis implementation of the JOBS Act, but I think it may be the first time he has used internal SEC emails against her.

Certain of the internal SEC emails, Rep. McHenry cites in footnotes but does not quote, to support the assertion that the head of the SEC's Division of Corporate Finance, Meredith Cross, and her staff, were poised to proceed with recommending that the Commission publish "final interim rules" to give effect to the lifting of the ban on general solicitation, before Chair Schapiro intervened out of, as Rep. McHenry has it, an unseemly preoccupation with her legacy and an undue regard for a particular lobbying group.

It's little secret that the Commision changed plans at the last hour, publishing proposed rules rather than interim final rules. At the time, Chair Schapiro had said she felt it important to hear from other parties who had more to say about how to implement the lifting of the ban on general solicitation. I live-blogged the SEC open meeting at which the Commission's decision to publish proposed rules was taken; here's a link to that post.

What's missing from McHenry's November 30 indictment of Schapiro is any appreciation for just how substantive the ensuing comments - on the proposed rules - have been. Regulators and investors alike did not like the proposed rules. (I loved them. The SEC got it exactly right, and it's a shame, in my view, that the proposed rules weren't in fact interim final rules.)

Of course, the largely negative reaction to the proposed rules may justify yet further delay. That's because, at least if the SEC's staff heed the outcry for definitive safe harbors, the next step will involve more than simply tweaking the proposed rules.

If it's now unlikely that the Commission can go back and implement, as final rules, the rules as first proposed, is it possible that Rep. McHenry could do something legislatively to get the outcome he desires? If he thinks the proposed rules reflect what the SEC staff were ready to recommend as interim final rules,what about a bill to mandate immediate amendment of Rule 506 according to the language of the implementing rules as the SEC staff proposed them?

The House might even pass such a bil. Though the Senate probably would not.

Rep. McHenry's shots at Chair Schapiro don't strike me as fair, but there is no question that politics are being played by Chair Shapiro as well. She has a view about the need to reform Reg D and the world in which angel investors are allowed to invest in whatever they damn well please, and it's way more paternalistic than Rep. McHenry's view.