My Favorite Part of the JOBS Act

There has been a lot of ink spilled about the JOBS Act, especially its “crowdfunding for securities” provisions. The JOBS Act is an exciting piece of legislation for the startup community. What is my favorite part of the Act? Section 201 (quoted below).

Why is Section 201 my favorite section and not Section 301 (the crowdfunding exemption), or Sections 101-108 (the IPO on-ramp provisions)? Because Section 201 will dramatically change the playing field for the investment rounds that I am most actively involved in–all accredited investor Rule 506 offerings under the 1933 Securities Act.

Crowdfunding has promise, but currently 95% of all private securities offerings are done via Rule 506 of Regulation D. In other words, Reg D Rule 506 is where the game is played. In my opinion, startup companies will continue to predominantly rely on Rule 506 offerings to raise capital due to limits on crowdfunding contained in the JOBS Act. Unfortunately, the crowdfunding provisions in the JOBS Act are not what advocates hoped for (see my previous critiques here). Regardless, let’s look at the bright side for a minute with respect to Section 201.

What will Section 201 do for 506 offerings?

  • It will allow companies to advertise to the public that they are engaged in securities offerings, without costing them the 506 exemption. This is a dramatic and astounding change from the previous ban on general solicitation. Companies could run ads in the NYTimes or the WSJ if they wanted to, for example.
  • Even if they don’t advertise, companies will no longer have to be silent when they raise capital. Companies could not only advertise to the public, but they can talk to the press about their offerings.  This has been a regulatory “gotcha” for companies for a long time.  So many startups have unwittingly been caught in the following scenario:  First, you file a Form D within 15 days of the first sale of securities (as required by the SEC), then after seeing the public filing, the press calls, and you inadvertently talk about your offering and blow your 506 exemption by violating the ban on general solicitation.
  • Companies will be able to post on their web sites that they are raising capital. Rule 506 offerings may not be as democratizing as crowdfunding, but they may come close as old barriers about how companies can connect to investors melt away.  Companies no longer will have to rely only on word of mouth or people with whom the company had preexisting relationships to reach out to investors. Web sites indexing and rating offerings by private companies will probably spring up. Look for Angel List to become even more  significant.
  • Companies will no longer have to worry about blowing their Rule 506 exemption by pitching at seminars or meetings where  “attendees have been invited by any general solicitation or general advertising” (quoted from the current version of the rules). Under the current rules, this was a real risk (albeit one not too many companies concerned themselves with).

These are all, in my opinion, very welcome and positive developments for the startup community.

What To Look Forward To

The SEC must act within 90 days of the enactment of the JOBS Act to revise the current rules to “provide that the prohibition against general solicitation or general advertising” not apply to Rule 506 offerings, provided that all purchasers of the securities are accredited investors.

What Could Go Wrong?

Not to be cynical, but we will have to wait and see if the SEC’s proposed regulations actually carry out the intent of the JOBS Act. For instance, Section 201 states that the new rules are going to “require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.”

Let’s hope the SEC does not impose burdensome information gathering and disclosure requirements on companies. We have already seen how the “bad actor” provisions spun out of control in the regulatory process:  In the bad actor case, the SEC proposed an onerous “did not know, and in the exercise of reasonable care could not have known” standard of diligence for companies identifying potential bad actors.

Let’s hope the SEC does not take the same tact with these new regulations.

TITLE II—ACCESS TO CAPITAL FOR JOB CREATORS

SEC. 201. MODIFICATION OF EXEMPTION

(a) MODIFICATION OF RULES.— (1) Not later than 90 days after the date of the enactment of this Act, the Securities and Exchange Commission shall revise its rules issued in section 230.506 of title 17, Code of Federal Regulations, to provide that the prohibition against general solicitation or general advertising contained in section 230.502(c) of such title shall not apply to offers and sales of securities made pursuant to section 230.506, provided that all purchasers of the securities are accredited investors. Such rules shall require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission. Section 230.506 of title 17, Code of Federal Regulations, as revised pursuant to this section, shall continue to be treated as a regulation issued under section 4(2) of the Securities Act of 1933 (15 U.S.C. 77d(2)).

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About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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  • http://www.compliancebuilding.com Doug Cornelius

    Since I work for a private fund manager, Section 201 is also my favorite.

    The one downside is that the rule cuts out all non-accredited investors. Previously you could have up to 35 outlier as long as they were “sophisticated.”  Those sophisticated, but non-accredited investors will be excluded. That may impact some friends and family funders.

    • http://wac6.com/ William Carleton

      Doug, Joe, do you guys think 201 can be read to allow that the old 506, where 35 non-accrediteds are allowed, can still apply, as long as there is no general solicitation?

      • http://www.compliancebuilding.com Doug Cornelius

        I think it can be read that way, but I’ll sit back and wait for the SEC rules to see how they read it.

        We know the SEC is opposed to this rule. Most of the commissioners have said so publicly. I expect the proposed rule will take a hard line while still staying within the bounds of the statute..

        • http://wac6.com/ William Carleton

          I thought it was interesting that one of the Senate versions of Title II – it failed to go anywhere; the Senate only had impact on Title III, the crowdfunding piece – called instead for a new rule to be added to Reg D, Rule 506A you might say, that would be modeled on 506 but be limited to accredited investors whose accredited status was verified. Just speculating, I know, but had that approach won the legislative day, we might have preserved current Reg D Rule 506, which is almost an honor system vis a vis verification, and had a different, more “public” Rule 506 variant, where general solicitation was okay, but the “cost” of that liberality was tougher scrutiny of the status of the investors.

    • joewallin

      Doug, when I do 506 offerings, I’ve always kept them to all accredited investors because if you even let 1 non-accredited in your information disclosure obligations go through the roof.

  • http://www.compliancebuilding.com Doug Cornelius

    Robert Brown raises some other interesting weaknesses in Section 201:
    http://www.theracetothebottom.org/home/2012/4/5/the-jobs-act-and-the-capital-raising-process-general-solicit.html
    Hopefully, the SEC will clean this up through its rule-making.

    • joewallin

      I think this is the link: http://www.theracetothebottom.org/home/the-jobs-act-and-the-capital-raising-process-general-solicit.html

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