155 posts categorized "Reg D"

SEC official to angel community: go ahead, develop your own verification methods!

Keith Higgins, the relatively new Director of the Division of Corporation Finance, delivered a speech at the closing session of the 2014 Angel Capital Association Summit - and was it a doozy!

A huge issue for angel investors is the "reasonable steps to verify" accredited status that is part of new Rule 506(c), which permits issuers to engage in "general solicitation." The issue was a focus of at least two breakout sessions at the Summit, including one Thursday moderated by ACA policy chair Mike Eckert that I participated in with the gifted lawyers Peter Rosenblum and Rob Rosenblum (not related), and an excellent breakfast briefing Friday from K&L Gates lawyers Gary Kocher and Kevin Gruben.

1842308438_83cb923365_oThe reason for such attention is the anxiety caused by the non-exclusive verification "safe harbors" set out in Rule 506(c). These verification methods contemplate that, going forward, an issuer is going to have to demand personal financial information from investors, or engage third party verification services to do so. To many readers of the new rule, including a majority of securities lawyers, the safe harbors - in spite of the "non-exclusive" label - feel destined to prove de facto requirement.

But Higgins said that needn't be the case.

In his speech (the full text of which you can access on the SEC's website), Higgins emphasized that if any verification standard might be core under Rule 506(c), it is the flexible, "principles-based" approach laid out in the inital release proposing the new rule:

"These [applications of the principles-based method] are all part of a deliberate effort by the Commission to provide issuers with an alternative to the clear but highly prescriptive list of verification methods included in the rule. In fact, it is ironic that this list of verification methods is being viewed by some as the primary way to verify a purchaser’s accredited investor status when, in fact, the Commission originally proposed the principles-based approach as the way issuers would comply with the rule’s verification requirement and added the list of specific verification methods only in response to address the concerns of commenters who wanted more certainty."

As Gary Kocher explained plainly in his breakfast briefing earlier in the day, lawyers are a conservative bunch, and naturally are going to navigate to the safe harbors. But, Gary stated he believed that the staff meant what they said in the rule and in the release, that the principles-based approach was viable. I think Higgins' speech completely validates Gary's view.

All of this portends well for verification methods based on the Angel Capital Association's Established Angel Group guidance, which would not require the turning over of sensitive financial information to issuers or their vendors.

As for seeking express SEC staff blessing of particular applications of the principles-based method of verification? Higgins seemed to say that was both not likely to be forthcoming anytime soon, and also beside the point:

"On that note, we have had recent inquiries asking whether the staff would provide guidance – presumably on a case-by-case basis – confirming that a specified principles-based verification method constitutes 'reasonable steps' for purposes of the rule’s requirement.  The notion of the staff reviewing and approving specific verification methods seems somewhat contrary to the very purpose of a principles-based rule and I am not yet convinced of the need for this type of staff involvement. Rather, this is an area where issuers and other market participants have the flexibility to think about innovative approaches for complying with the verification requirement of the rule and use the methods that best suit their needs. While the staff may not be in a position at this point to provide guidance on what constitutes 'reasonable steps' under particular circumstances, I also believe the staff will not be quick to second guess decisions that issuers and their advisers make in good faith that appear to be reasonable under the circumstances."

I should note that the angels I spoke to at the Summit, and the questions they posed in the breakout sessions, were more precisely focused on the definition of general solicitation and the activities at pitch events and the like that might push a company from 506(b) territory into 506(c) territory. But let's step back a second and look at the problem from just a story or two higher: to the extent that verification under 506(c) becomes more manageable, then the general solicitation issue becomes somewhat less of an existential distinction. (There may yet be reasons to avoid publicly soliciting investors - but that is another topic.)

Success for principles-based verification approaches will not be self-executing. Angels and their entrepreneurs will have to insist on them, and will have to make sure they have enough rigor to acquire respect. In the right circumstances, lawyers for a given deal might, just might, go along.

Drawing: "Principles Mound" by Paul Downey / Flickr.

What exactly is crowdfunding?

This morning I took part in a panel at the Thompson Reuters 2014 Online Financial Services Symposium.

Moderated by Suzanne Barlyn of Thomson Reuters, the topic was "disruptive alternatives," including crowdfunding and peer-to-peer lending.

Bjkz7mTIQAEPKAkThe audience is made up of financial services professionals who manage online trading and other retail financial services on a massive scale. As I blog this, a panel is getting into the nitty-gritty of trade execution. A later panel will talk about user interface design and new ways to engage both self-directed and managed investors (and how the categories are blurring).

So I hope that lends context. The panel I took part in was to discuss new classes of investing that might be around the bend for the mainstream online financial services industry.

6a01156e3d83cb970c01a3fcde8425970b-580wiSomething big that I learned in the course of the morning is that peer-to-peer lending is something not far off into the future, like Title III non-accredited crowdfunding, but a phenomenon already here and even embraced by policy makers at the Federal Reserve. Ron Suber (pictured) of Prosper, a San Francisco based marketplace matching consumer borrowers with lenders, captured everyone's imagination with his vision of disintermediating banks in the consumer credit space. He calls it an investable asset class, and emphasized the pains taken to qualify would-be borrowers (eighty percent of applicants are turned down, he said).

Closer to the world with which I am more familiar - equity financing provided by accredited investors to startups - Michael Raneri of Venovate, another San Francisco-based company, described a sweet spot for online activity that is post-seed stage (later than AngelList or FundersClub), but still very much emerging growth. His company is part broker, part part portal, part VC fund (or maybe fully all three). He does not appear to like the term "crowdfunding," however, for the connotations it brings of Title III.

BjlGgPNIUAAnRkwTim Baker, Global Head of Content Strategy at Thomson Reuters, reminded all that angel and venture financing is relatively small - only about $25 billion a year. He cited historical precedents which suggest to him that, if crowdfunding on the equity side is going to take off, it will take 5 years or so to catch on.

If Tim is right, I imagine that, in that span of time, people will get comfortable with the idea that some kind of clearinghouse will standardize accreditation. When that happens, the 506(b)/506(c) distinction - so very existentially critical in this moment of transition - won't be as big a deal. 

So debt crowdfunding at a retail level is here already. And accredited crowdfunding (Tito Singh of Thomson Reuters terms it "elite crowdfunding") is finding its footings and will likely impact angel investing as we know it. What about equity crowdfunding for everyone?

I know there are people in the nascent non-accredited crowdfunding industry, who see non-accredited crowdfunding of startups as a asset class. That is a mistake. In fact, part of why I like the state crowdfunding alternatives (alternatives to JOBS Act Title III) is that they seem to take more of the approach that people want to back small companies for reasons that are as compelling or more compelling than the prospect of financial return.

Picture credits: first two, Lauren Young of Thomson Reuters (from her tweet stream); third is picture I took from the dais of Suzanne Barlyn before she took the podium.

Bad actors, general solicitors, and other troublemakers

Big, big changes to Reg D filing requirements are potentially in the works, ranging from dire penalties for failure to file, to prefiling requirements to crimp the efficiency of Rule 506(c) offerings.

But these changes to Reg D filing requirements are in the works. They may not happen. Or, if they happen, they may be other than the changes first proposed.

8287466073_590433fbab_oMeantime, however, other changes have been implemented under Dodd-Frank and the JOBS Act, taking the form of final rules that impact day-to-day financings claiming exemption under Rule 506(b).

I'm thinking here primarily of the bad actor rule, now a part of Rule 506, and the renewed attention to general solicitation, which you want to track for purposes of reassuring yourself that you really are inside Rule 506(b) (which continues to prohibit general solicitation).

I thought it would be interesting to drive by how these changes to the law are being reflected in stock or convertible note purchase agreements.

Here's a bad actor rep and warranty from Bo Sartain - the party giving the rep here is the purchaser:

No Disqualification Events. Neither the Investor nor, to the extent it has them, any of its shareholders, members, managers, general or limited partners, directors, affiliates or executive officers (collectively with the Investor, the “Investor Covered Persons”), are subject to any Disqualification Event, except for a Disqualification Event covered by Rule 506(d)(2) or (d)(3). The Investor has exercised reasonable care to determine whether any Investor Covered Person is subject to a Disqualification Event. The purchase of the Shares by the Investor will not subject the Company to any Disqualification Event.

Pretty straightforward. A company asking an investor for such a rep may need to do more to look into whether the person is indeed a bad actor or not; but the rep doesn't hurt.

Investors, of course, may want a similar rep from the company - that the company's insiders don't include a bad actor.

And investors concerned with the risks of a 506(c) financing will ask the company for reassurance that it did not engage in general solicitation in connection with the offering (or any prior offering).

Here's an interesting rep from the model stock purchase agreement promulgated by the National Venture Capital Association. What makes it interesting is that purchaser, not the company, is giving assurances as to general solicitation:

No General Solicitation.  Neither the Purchaser, nor any of its officers, directors, employees, agents, stockholders or partners has either directly or indirectly, including, through a broker or finder (a) engaged in any general solicitation, or (b) published any advertisement in connection with the offer and sale of the Shares.

Implicit here for companies is the suggestion that, not only do you have to take care to not generally solicit, but you may also need to worry about whatever tweeting or blogging your investors might engage in during the course of the offering.

Typesetting photo: Eva-Lotta Lamm / Flickr.

Ruth Simon and Angus Loten WSJ articles this week about use of 506(c)

Ruth Simon and Angus Loten of the WSJ have a couple of really interesting articles this week, by way of tracking just how people are using the new accredited crowdfunding rule:

5917135851_7ce6399d13_zBy "accredited crowdfunding rule," I mean of course Rule 506(c), the new rule that lets issuers engage in general solicitation and general advertising, as long as all purchasers are accredited, the issuer takes reasonable steps to ensure each purchaser is accredited, and the issuer otherwise satisfies the applicable requirements of Reg D.

This is a BIG regulatory change. Recall how everyone always used to say, don't talk to reporters about your offering! Don't tweet it, don't blog about it! That's the old rule, which remains in place, renumbered now as Rule 506(b).

Well, the upshot of the Simon/Loten WSJ pieces, is, arguably, the maxims that follow from the old rule are still, as a practical matter, still in place. Don't talk to reporters about your offering! Don't tweet it, don't blog about it!

That's because the conditions of the new rule are not trivial. And also because of uncertainty about proposed rules that would make compliance with 506(c) even harder.

The Simon/Loten articles do, however, speak to examples of folks who are using 506(c). And he pieces relay some WSJ data/analysis on how much money has been raised under 506(c) so far.

"Among companies that have filed with the SEC, those that disclosed their fundraising goals say they intend to raise more than $25 billion, according to The Wall Street Journal's analysis. Since the new measure was implemented, firms that claimed the exemption and have since netted their first investor have raised a total of $1 billion, the analysis shows."

Thanks to Catherine Mott for pointing me to the Simon/Loten articles.

Image: Poster Boy / Flickr.

Early data on use of 506(c) (accredited crowdfunding)

Recent remarks by Keith Higgins, newly appointed Director of the SEC's Division of Corporate Finance, give us some early data on how issuers are making use of new Rule 506(c).

You'll recall that 506(c) is the rule that implements the lifting of the ban on general solicitation in offerings that otherwise meet the applicable Reg D requirements, and also limit purchasers to accredited investors who are subjected to a heightened verification standard. "Implements" refers to the Congressional mandate to do so, under the JOBS Act. (It's interesting to me that Higgins at least once in his written remarks refers to the Congressional mandate as "requiring the Commission to modify the prohibition against general solicitation," emphasis added.)

10727208825_da46007c6f_z

In a footnote to his written remarks, footnote 18 on page 10, Higgins relays the following information from the SEC's Division of Economic Risk Analysis (DERA):

"Based on the information reported in the initial Form D filings reviewed by DERA, as of October 18, 2013, there have been 170 new offerings made in reliance on the new Rule 506 exemption that became effective on September 23, 2013, with approximately $911 million in total amount sold in these offerings. In addition, 44 offerings that commenced in 2013, but before the effective date of the new Rule 506 exemption, were subsequently converted to offerings relying on the new exemption. Since the new rules became effective, the average offering size for Rule 506(c) offerings was $6.1 million, as compared to $22.8 million for Rule 506(b) offerings; the median offering size for Rule 506(c) offerings was $1.3 million, as compared to $1.8 million for Rule 506(b) offerings.

What does this suggest? Well, that issuers (be they startups or hedgefunds, we can't really tell from this data) are using 506(c); and that generally solicited offerings may be targeting smaller amounts than traditional 506 deals.

You may be thinking, the modest number of filings - some 200 - seems too small. After all, weren't thousands of startups going "public" with their "private" offerings on AngelList within hours of 506(c) becoming effective on September 23?

Ah, but recall that the filing deadline is 15 days from first sale. So there should be a healthy lag, at least as long as the current filing requirements remain in place (recall that proposed rules are out, imposing pre-filing requirements for 506(c) deals and lots of other not-so-fun changes for both 506(c) and 506(b)).

Thanks to articles by Broc Romanek and Sarah Lynch for identifying Higgins' testimony.

Wisconsin leaders support equality in angel investing

Really pleased to see that the Wisconsin LGBT Chamber of Commerce and the Greater Madison Chamber of Commerce are adocating for equality for same-sex couples in angel investing.

Here's a link to the press release. And here's a link to a letter they have written to a member of Congress from Wisconsin.

CaptureCKudos to Zach Brandon for his work on this. I got to know Zach from serving on a panel with him at the ACA Annual Summit a year or two ago. He is a leader in the angel community and it will be people like Zach, stepping up, that will eventually change consciousness on this issue. Right now, it's a sleeper. Few want to talk about it, but, the perverse reality is, the SEC rules for angel investing treat same-sex couples as second class.

Here's the rule change that the Wisconsin LGBT Chamber of Commerce and the Greater Madison Chamber of Commerce advocate, as does Startupequality.org:

A spouse of a natural person shall mean another person, regardless of gender or sexual orientation, whose relationship with the person specified: (1) may be characterized as such person's (i) husband, (ii) wife, (iii) spouse, (iv) domestic partner, or (v) designated beneficiary under any applicable state law for the purpose of ensuring that each person in a two-person relationship has certain rights or financial protections based upon such designation; or (2) is that of the other party to a civil union with such person.

Feeling sorry for the rule drafters, in advance

So it looks official: the SEC has set up a meeting for tomorrow, Wednesday, to consider proposed rules to implement Title III crowdfunding under the JOBS Act.

(Ordinarily, I would live blog the open meeting webcast. Work commitments are likely to keep me from doing that tomorrow.)

Capture111We won't know until the meeting whether the Commissioners will authorize the release of the proposed crowdfunding rules. But as Sarah Hanks tweeted, it's doubtful that the SEC Chair would have called the meeting, if she didn't think she had the votes to approve the proposal.

Already I feel sorry for the Commission staff. Sorry, because I know many are going blame them for how unworkable the proposed rules will be.

Am I predicting that they will botch translating the Congressional mandate under the JOBS Act Into a workable rule set? No, I am not predicting that.

Instead I am predicting that the SEC will do a credible and fair job of honoring the legislation.

And therein lies the problem.

It is Title III, the crowdfunding legislation passed by Congress, that is not workable. As I've written before, good rule-making can't fix fundamentally broken legislation.

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