Today's post is a transcript of a Spreecast that Joe Wallin put together, in which Joe, Doug Cornelius and I talked about general solicitation and the bad actor rule.
The transcript was put together by Jerome Gentolia. Jerome, thank you! Incidentally, if you don't know Jerome as a tweeter, you should consider following him. He has the beat on all posts and articles related to startups.
Joe: Welcome everybody!
Bill. Welcome, Doug. Welcome, viewers!
I’d like to
introduce you to what we are going to talk about today. We are going to talk
about General Solicitation for startups. In particular, the rules that goes in
effect today on September 23rd. A big day in securities law.
Cornelius who blogs at www.compliancebuilding.com
is going to speak first. He’s going to
speak with us today about the rules that actually went into effect today. Then
we are going to hear from Bill Carleton who blogs at www.wac6.com.
Bill is going to talk about what rules did not go into effect today,
because there has been some confusion about that in the media, and then I’m
going to summarize and close up shop. So, at this point I would like to turn
this over to Mr. Doug Cornelius.
Doug: Hey! Thanks Joe. So, two things went
into effect today; the first one is probably the easiest and less controversial,
that’s the “bad actor” rule under 506D.
says if you have an officer, director, affiliate, promoter or a significant
investor who has committed a financial crime the last 10 years, you have to
disclose that to investors before selling securities.
they commit the crime, they’re disqualified from participating in private
placement. The rules are not retroactive going back 10 years for the
disqualification. So you need to tell your folks today to stop committing
financial crime if they ever wanted to have a private placement in the next 10
some complicated aspects to it, but I don’t think too many people are concerned
about that rule.
The other one
that went into effect, which is probably the bigger news, is the S.E.C. finally
implemented the congressional mandate from the JOBS Act to lift the ban on General
Solicitation in advertising.
we get into that, if you like private placement just the way they are, as long
as you comply with the “bad actor” rule, you can keep doing exactly what you’ve
been doing with private placements, because the S.E.C. did not remove or alter
the existing private placement regime.
The new private placement regime, if you want
to engage in General Solicitation in advertising, a term that is not well
particularly defined, and the S.E.C did not make any effort to get a better
definition to do.
But if you
want to carry out with engaging in General Solicitation and advertising, is
that you now need to take reasonable steps to verify that the investors are accredited
and all investors have to be accredited.
So you have
to take those reasonable steps to get to the reasonable belief that they are
accredited investors. In terms of what those reasonable steps are, I think
that’s something we still are all trying to work out. The S.E.C. did give for non-exclusive
safe harbors for individuals who might
be investors, none of which are particularly satisfying.
The first one
is you can ask your investor to provide their W2’s or tax returns to show that they have met
the income test to the accredited investor standard.
The other one
is to prove assets by providing banks statements or brokerage statements that
show you meet the net worth requirement. Although the S.E.C. said there can be some
issues on how you disclose liabilities that may offset those assets.
The third one
is probably the more interesting, which is use of a third party verification,
such as broker dealer, investment advisor, lawyer or CPA; and the fourth one is actually a
grandfathering rule that if you have an investor in the existing private
placement within the same company, they’re grandfathered in.
they did in wrapping around this for defining reasonable steps, which is a step
that I thought they would do, was provide a minimum investment threshold, which
would prove that you are an accredited investor, since to be an accredited
investor, you have to have at least a million dollars in net worth. Some dollar
amount of money should make it enough that you are automatically an accredited
S.E.C seems to be very concerned that people can borrow the cash rather than
actually have the cash on hand. I think
this will probably end up being a dividing line between larger fundraising and
smaller fundraising. I think if you’re raising a million dollars, you have a minimum
investment threshold of a million dollars, you may be pretty comfortable with
that given having basic information about the person who is coming in as an
thing that the S.E.C. specifically said, which is that merely having a “check
the box questionnaire” is not adequate. Not adequate as a reasonable step to
prove that one meets the threshold of an accredited investor and that had been
the existing standard as far as I know, for almost every private placement.
Which is just to have the investor fill out a questionnaire and then you can
move on. By getting rid of that, I think that put a serious crimp in the new, as I am
calling it, the new public private placements as opposed to the old private
certainly spend a great deal of time talking about the ins and outs of all of
these two different rules, but I think there is a bigger concern in what didn’t
come into play. I bet Bill has more information on that… or not.
Bill: Yeah. I guess that’s my cue.
There’s a lot
of confusion about this. The same day that the final rule 506C and the “bad
actor” rule that Doug just talked about, were approved on July 10th
in a meeting with the S.E.C.
just coming into effect today because there’s some administrative law thing about
publishing and the federal register having a certain number of days go by.
are in effect, but the same day those two final rule sets were approved, a new
rule set, not mandated by Congress, was proposed by the S.E.C. and that would
change 506c. The rule that was not yet in effect at the time these proposals
were proposed and it would also change soon to be 506c because it would impose new filing requirements
in the case of 506c, if you’re going to generally solicit the proposed rules
would say you have to file a Form D 15 days in advance of general soliciting.
You have to
file all written materials you use in connection with general solicitation, no
later than the day you first used those materials in general solicitation. You
have some post filing obligations and a whole bunch of new draconian rules that
Joe Wallen has nailed better than anybody on the bad consequences that happen
if you don’t file your Form D and giving the Form D requirements is something
that would straddle over the 506C
fence and apply to 506B, as well. So, big deal, not good news, but
that’s not what we are dealing with today.
Today we are
only dealing with verification. Today we are only dealing with the final rule
of 506c. Issuers can take startups, anybody raising money in allowance of 506c
of general soliciting. There were, when I looked about an hour ago, there were
something like 1,080 startups, publicly soliciting funds on Angelist.
Circle Up for
the first time has companies seeking financing on its landing page. This is
going big, real fast on the platforms and they are doing it in a window here,
where who knows what the transition rules will eventually say, but they don’t
have to comply with the pre-notice filing or information filing requirements of
those proposed rules because they are not in affect and I was going to say, issuers
startups have a lot of comfort when the new S.E.C. chair Mary Jo White wrote in
a letter to Patrick McHenry that the rule goes into effect today and that
issuers relying on the new rule will have to comply with the conditions of the
new rule, of course, but they do not
have to comply with the proposed rules.
So, I think
today, maybe tomorrow, and for who knows how long, we are getting general solicitation
in angel deals as congress intended it, I think it’s fair to say because the
idea of verification, which is not trivial, this heightened verification
requirement is causing a lot of confusion and consternation and there are
angels that are not pleased with it and some groups saying they will only do
506b. I know some serial entrepreneurs who are saying they will not do 506c,
but first time entrepreneurs are going to 506c, a lot of valley entrepreneurs
are going to do 506c. I’m noticing some people in Seattle are in that group on
Angelist that are publicly soliciting. We are going to have people that will be
using 506c. For a period of time, that verification requirement that Congress
imposed is the only string.
string is that in 506c you can’t include 35 non accredited investors, but at
least in my practice and I’m betting you guys too, you never really saw people,
at least in the startup eco system, you didn’t see people including
non-accredited investors under the old rule anyway for reasons we don’t
necessarily have to get into.
Doug: Yeah, yeah, I’d think you’d see it in
more of the friends and family aspect which are not going to be allowed in.
Bill: Right, Right.
Doug: The other thing to point out is that
this is not the crowdfunding rule, which people have also been jumping a bit
out of the S.E.C. since the JOB Act passed
Bill: Joe, I know you’ve been mentioning
today that the major media that are getting those two confused. Like crowdfunding
and angel General Solicitation.
Joe: Yeah, I think a lot of people; I think there have been a
number of media pieces which have confused the appeal of the ban of General
Solicitation with the crowdfunding rules and so that have been unfortunate.
But just too
kind of summarize where we are at, right now, today, we are getting General
Solicitation as the Congress, we think, intended, when it passed the JOBS Act.
But sort of the big open questions are what might the S.E.C might do with the
proposed rules; the comment period for the proposed rules ends today. You can
still comment. The comment window is still open right now. I don’t know for how
many hours it will be open.
I know the
S.E.C’s committee on small startups and emerging companies requested that the
S.E.C. extend a period of time for comment. I think that would be a great
thing, if the S.E.C extended the comment period, so more people have the chance
to put comments in and I think perhaps for the other open issues list, there is
still lingering questions about what does constitutes General Solicitation.
The S.E.C. has
historically said that is a question of fact. That they can’t necessarily opine
on and Dan Primack, the great blogger from Fortune wrote a great piece on that
and I think that’s; one of the thing we’ll hopefully get some guidance from the
S.E.C. on that does issue the final rules, if it ever does issue final rules. I
guess we’re all hoping they will just sort of go away. But maybe if they do
finalize them they can give us some clarity of what those concepts mean and
then finally, I think the other thing that is sort of put on the open issues
list is at least some states have blue sky laws, which might raise questions as
to whether there are additional filing requirements. For example; New York State,
I’m not sure if we have an answer yet from and of the New York lawyers as to
whether there are any special filing requirements in New York if you generally solicited
in that state.
In any event, this is sort of my own open
issues, I don’t know if Doug or Bill, I’m sure we can go on talking about open
issues all day, but I don’t know if you have anything to add to these high
level open issues that I just mentioned or not.
Doug: I expect that there will be something
more coming out. I think if you look at sort of being able to put, I come from
the private fund direction less than the startups, is the mutual funds that
everybody has been able to invest in for a while have some very strict
requirements about advertising. But now hedge funds, these private funds aren’t
going to have those same restrictions. I expect there will be a big push to
level that playing field to some extent, in terms of disclosures and methods of
The other is
sort of the investor of protection piece, which the state regulators are particularly
concerned about. When it comes to private placement, they are supposed to be
private, so to the extent of the security regulators are able to see
information about our private placement. They know something is wrong. Either
the company got some bad advice in terms of what they could do or it’s a scam.
Either way, the state regulators could step in and do something about it. Now
they are going to be presented with a situation that they don’t know anything
about, what this offering may be. They won’t even have the minimum information
from a formD filing to know what is going on with that particular investment
Joe: Right. Bill, do you have anything to add before we
declare… go ahead.
Bill: What Doug was just describing is
getting back into the substitute debate on whether general solicitation is a
good idea or not. If you follow the conceptual argument that underlie the idea
of lifting the ban on general solicitation, which was you’ve got investors that
can fend for themselves, I mean the investor protection that congress picked
and was just a verification requirement making sure that people really are
accredited. If people are having to the extent that people are second guessing
that and requiring more. Another flank on this pressure point, another place
where the stress can be relieved, where the steam could come out can be in
putting more pressure in the accredited investor definition. So, just to kind
of cut to the chase, you could see people say, look, we are not going to get,
we are not going to shut down 506 with a bunch of information requirements,
let’s just make it harder to be an accredited investor and raise the standard
and I don’t think that would be a good thing. It would take some pressure off
of the move of information requirements on 506c.
Joe: Right and the S.E.C. and its proposed rules, the comment
period, for which ends today, the S.E.C. did seek comments, did solicited
comments of the definition of an accredited investor. So, it’s interesting,
Bill: I would hope that they would just put
the proposed rules away with their whole entertaining of changing accredited
investors standard and just let 506c, the verifications are a lot to digest,
there is a lot of confusion about that. Are these non-mandatory methods in
effect the only methods? Or can you use some facts and circumstances? It’s
going to take a while for people to sort that out and best practices to come to
the floor and whether people like the Angel Capital Association guidance
whether that will take and will keep Angels involved in the system at a level
that they are right now and maybe just leave it alone for a year. We’ll see
Doug: Personally, I think it’s coming from
the wrong direction. I think what people are really looking for is better
guidance around what general solicitation and advertising, what that definition
meant. I think probably most attorneys would look at things like VC Days and
Demo Days and say, “that’s general solicitation and advertising.” I’ve never
seen any sort of enforcement action about something like that. If the S.E.C.
had just set up a car belt from that, I think that would have removed a lot of
people’s concern. Being able to talk to the press to correct mistakes, I know
private funds in the past haven’t been able to respond to a mainstream news
article that sort of mis-states what they’re doing when they are in the middle
of doing an offering because they are afraid of blowing the ban on general
solicitation and advertising, now I think there are some things that are
Bill: I think you’re talking about being
able to stay in the 506b world, right? About 506c not swallowing it up?
Doug: Right. And really when it comes to
startups, if they’re going to advertise, they are probably much better off
advertising their product than advertising their securities. I would be
skeptical about putting my money into a company and spending a whole bunch of
money advertising for securities instead of putting that money into developing
a product and advertising their products. I think what people want to do is not
trip over this ban on general solicitation and advertising and I think they
took a sledgehammer to it by lifting the ban, which raises all of these
investment protection issues. Instead of just saying, look, there are these
things that we are not concerned about on this ban for general solicitation and
Joe: That certainly would have been a different approach and
maybe a better approach, but we have to live with where we are.
Again, we should take precautions. We shouldn’t be blaming the S.E.C. for these
rules that are active today. At least we are following exactly what Congress
told the S.E.C. to do. There are rules that are funkier than the S.E.C. trying
to deal with all of the comments and dealt with all of the concerns of investment
protection and restoring a balance between mutual funds and hedge funds and I
think that is where most of the confusion is going around.
Joe: Well, it will be fun to watch and see what happens. Guys,
before we sign off, is there any last closing thoughts you want to share?
Bill: I think it would be interesting to
follow the AngelList site throughout the day and look at their ticker on their
homepage and just see how many startups, hour by hour are opting into 506c.
Joe: And Bill, you are live blogging now at wac6.com, right?
Bill: Yeah, It is not as successful today,
Joe, as it was when you, Doug, Laurie Smith and I lived blogged that S.E.C.
meeting last week because we didn’t get Doug today and you’ve been busy with
other things, but heck, I’m throwing a few things up there every hour or two.
Joe: Well maybe Dan Primack will join you later.
Bill: That would make it successful.
Joe: We’d have success. Doug, any closing thought?
Doug: It would be interesting to see who
jumps into this gap about being able to verify investors. I think there is
certainly an opportunity for the Angel Capital Association or some equivalent
to step in to provide that service. So you don’t have to deal with the ugly
aspect of having some startup collect W2’s or bank statements.
Bill: I saw Dan’s comment on that just now
and in fact, I took a screenshot of their 506C, W2 upload form, they are
thinking about it in a very thoughtful way and they are hoping that because
they are well capitalized and because they are subject to all of these broker
dealer rules and because they have a secure site that people will feel less
nervous about uploading their information to them, then to a three person
garage startup that doesn’t have all of the security and privacy control
policies worked out.
Joe: Alright, well Doug, thank you for your time. Bill, thank
you for your time. I’ve enjoyed talking to you and thanks to all of our
listeners and Dan, thank you for chiming in your comments, those are great
Bill: Good hosting, Joe!
Joe: See you all soon.