Perhaps it was no surprise when Mary Schapiro, Chair of the Securities and Exchange Commission, told a House subcommittee that the Securities and Exchange Commission will not meet the July 4, 2012 deadline impose under the JOBS Act to implement rules for lifting the general solicitation ban under Regulation 506, Section D.
Ms. Schapiro explained to the House Committee on Oversight and Government Reform on June 28, 2012 that the JOBS Act mandates that the SEC create rules that will require issuers to verify that they are accepting investments only from accredited investors who are responding to a general advertisement. Creating such rules are difficult and will require more time. “We want to create something that is workable and usable,” she said. The SEC Chair expects that general solicitation rules will be issued “this summer.”
The SEC’s commitment to provide general solicitation rules this summer is encouraging and badly needed. Representative Patrick McHenry probably summed up the urgency for the rules the best by advising Ms. Schapiro: “Entrepreneurs are waiting and we urge you to move forward with that.”
As the SEC develops rules for general solicitations, issuers must understand that they will need to move cautiously if they plan to use general advertisement to solicit offerings. The JOBS Act requires that issuers verify that they are accepting investments only from accredited investors under the SEC Act. The SEC rules ultimately will determine what verification process is needed and whether any safe harbors are available. We suggest that issuers looking forward to making general solicitations stay apprised of developments as the SEC formulates its rules, so that issuers are prepared to move forward when the rules go public.
The Securities & Exchange Act in 1933 required that only accredited investors could be solicited for investments and non-accredited investors could not be unless they had an exemption through Reg A, Reg D, a Direct Public Offering or a registered security being traded on an exchange.
Under the 1933 Act, the accredited investor was considered someone who made $200,000 per year the previous 2 years and expected to make $200,000 the following year or a couple making $300,000. Under a later amendment adopted in 1982, another criteria that would allow you to qualify as an accredited and sophisticated investor would be that you had a net worth of $1,000,000.
While the Dodd Frank Act was under consideration, the SEC pushed for a high net worth amount for an accredited investor. This was highly opposed and removed. What was accomplished out of the Dodd Frank Act was:
a) The equity of your primary home would not count towards your net worth.
b) Debt surpassing your equity would count against your net worth.
c) The equity in your summer / vacation / secondary home would count towards your net worth.
The Dodd Frank Act also prohibited the SEC from adjusting the net-worth threshold for a natural person for 4 years.
If you take inflation into consideration, the $200,000 per year salary in 1982 would be the equivalent of approximately $1,000,000 today, and the net worth requirement set in 1982 would represent a net worth of approximately $10,000,000 today. Wow, that would not leave many people to invest. Another argument would be that are only rich people entitled to invest in private and exciting deals? Are the select few that made money on Facebook the only ones to ‘give it’ to the less rich?
Granted, $200,000 makes you rich today but I was alluding to the rich just like their counterparts in 1933. Remember, the SEC 1933 & 1934 Act was created to protect the non-accredited investors from fleecing but also to assure that they did not leverage their home 99% and spend all their money on stocks that would not only be worthless but also make them jobless and homeless. The 1929 crash that led to the Great Depression was extreme.
While the status quo remains for determining the financial threshold of an accredited investor, a fundamental change is approaching on solicitation. Currently, any issuer intending to rely on Rule 506 of Regulation D cannot engage in any general solicitation or advertising to attract investors. The Jumpstart Our Business Startups Act (JOBS Act) directs the SEC to remove this prohibition, which the SEC expected to implement during the summer of 2012.
History of the Non-Solicitation Rule
Here is a little history on the non-solicitation rule. Be reminded that there was no TV or Internet in 1933. The ban on solicitation to non-accredited investors forced brokers and companies to only talk to ‘rich’ people for investments, that is, the accredited investors. The JOBS Act asked the SEC to change the writing in 90 days – that was July 4th, 2012 – Independence day – at which point advertising online, via email to millions or on TV, would allow you to advertise that you wanted capital for your stock to the general public.
Note, you still could only take money from accredited investors but the monumental change is that you can freely advertise wildly. Yet again, you would lose your exemption status under Reg D 506 if you took one single non-accredited investor and they decided to sue you later for loss of capital — a rare occasion but a legal premise that may hold true. So, will this amendment be implemented by July 4th and we will we see media go bananas, with everyone and their mother advertising stocks of private companies you can buy?
No, the SEC will not allow such madness as they will implement a safe harbor to assure that the ‘accreditation” of an investor through these means is verifiable and not necessarily just self-monitored by the issuer.
This article was written by David Drake of the Soho Loft.