The SEC’s Proposed Reg D Rules: Why We Care

Reg D Why We CareThe SEC has proposed new rules to govern angel and venture financings.

If you are not familiar with the securities law, Rule 506 of Regulation D is the most commonly relied upon securities law exemption for early stage companies raising money from angels and venture capital firms.

Currently, Rule 506 offerings are miraculously free of much regulation. As long as a financing is raised solely from “accredited investors,” no specified form of disclosure is required. A Form D must be filed, after the first sale, with the SEC and with each state in which the company or investors are resident, but the Form D is not that difficult to complete. AND the form isn’t due until 15 days after a company receives commitments from investors or closes on funds. In addition, right now, under the current rules, an inadvertent late filing with a reasonable excuse doesn’t jeopardize the exemption (at least at the federal level.)

The proposed rules, if they go into effect as the SEC has proposed them, will change many practices that have grown up and evolved over the last several years that are beneficial to the early stage company ecosystem.

For example, the new rules are going to require companies to file Advance Forms D at least 15 days before they conduct any general solicitation or general advertising.

What is the problem with this? The law doesn’t define what constitutes general solicitation or general advertising. (A fact that the SEC reiterates in its recent rules.) Instead, the law merely provides some examples of what constitutes general solicitation. What types of activities can put a company in the general solicitation box are not always clear. The concept is nebulous at the edges.

Penalties

Not only do the proposed rules require an Advance Form D filing, they impose a severe penalty on companies if they fail to timely file–disqualification from using Reg D Rule 506 for one year after the closing of the offering in which the failure to timely file occurred.

This new advance filing requirement, the lack of good definition in the law as to what constitutes general solicitation, and the onerous “penalty box” provision are a lethal combination for the early stage company ecosystem.

The penalty box is especially lethal because it binds founders. If you screw up with your first company, your next company is stuck too.

If the SEC had tried to dream up a way to throw a wrench into the early stage company ecosystem, it would have had a hard time coming up with something better than these proposed rules.

What about startup weekends? What about business plan competitions? What about incubator demo or graduation days? Will the teams that compete in these events be deemed to have generally solicited an offering? Some of these events, if conducted as they’ve been run in the past, will clearly constitute general solicitation.

Jean Peters, a member of the Board of Directors of the Angel Capital Association, made this comment recently on my blog, and the more I think about it the more I appreciate it:

    “Graduate high school. Check. Take SATs. Check. File Advance Form D for startup: World Domination.”

The SEC’s proposed rules are truly unfortunate. This 1 year penalty box could seriously harm startup companies that inadvertently miss filing deadlines.

What can you do?

Read the SEC rules.

Comment on the SEC rules.

Don’t miss your chance to comment. Your comment might be the one that turns the SEC around.

If you are looking for inspiration, read Naval Ravikant’s brilliant comment letter to the SEC. You may also find the site saveregd.org helpful. The Angel Capital Association also has a really good resource page.

Some suggestions for comments to the SEC:

  1. No advance filing should be required; filing within 15 days of first sale is sufficient.
  2. In fact, please, SEC, consider lengthening the 15 day period to 60 days.
  3. The penalty box is horrendous. There should be no penalty box.
  4. Instead of a stick approach, the SEC should consider a carrot approach. If you advance file, you should get an automatic forgiveness on any penalty box. Or if you are in a penalty box, a 30 day advance filing in your next financing should forgive you.
  5. Don’t forget SEC, to fix the inequity written about by @danshapiro in TechCrunch.

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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