March 25, 2013
Erica D. Greilich, on behalf of,
DOOR CLOSERS, INC., A Fictional Corporation
Advanced Securities Regulation, Spring 2013
University of the Pacific, McGeorge School of Law
3200 Fifth Ave. Sacramento, California 95817
916.739.7191
March 25, 2013
U.S. Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549
202.942.8088
RE: Release No. 33-9354 File No. S7-07-12
Dear Securities and Exchange Commission,
This comment letter addresses the requirements set forth by the Jumpstart Our Business Startups Act (JOBs Act), which requires eliminating the prohibition against general solicitation and general advertising in connection with Rule 506 and Rule 144A offerings under the Securities Act of 1933 (1933 Act). Based on the best interests of Door Closers, Inc., and our affiliate businesses, we take the position that: (1) the proposed amendments are mandatory in order to comply with the JOBs Act, and (2) the proposed amendments to Rule 506 and 144A offerings do comport with existing public policy and represent a positive step towards jumpstarting small businesses in these difficultly economic times.
I. INTRODUCTION
It is the position of the Securities and Exchange Commission (SEC) that in order to comply with the JOBS Act that it must make amendments to Rule 144A, Form D, and Rules 500, 501, 502, and 506 of Regulation D of the 1933 Act. According to the SEC, 201(a)(1) of the JOBS Act compels it, not later than 90 days after the date of enactment, to amend Rule 506 of Regulation D of the 1933 Act to permit general solicitation or general advertising offerings made under Rule 506, provided all purchasers of the securities are so-called accredited investors. Moreover, it is the position of the SEC that 201(a)(2) of the JOBS Act requires it, not later than 90 days after the date of enactment, to revise Rule 144A(d)(1) under the 1933 Act to permit offers of securities pursuant to Rule 144A to persons other than so-called qualified institutional buyers (QIBs), including by means of general solicitation or general advertising, provided that the securities are sold only to persons that the seller reasonable believes are QIBs. Finally, the SEC is proposing to amend Form D, the notice requirement to be filed with the SEC by each issuer claiming a Regulation D exemption, to add a check box to indicate whether an offering is being conducted pursuant to the proposed amendment to Rule 506 that would permit general solicitation. The SEC maintains that, in addition to believing these amendments are mandated by the JOBS Act it has considered comment letters previously received and believes that the proposed amendments represent the most appropriate solutions to the current issues.
This public comment addresses the following issues: (1) what does the JOBs Act actually mandate, if anything (2) how do Rule 144A and Rule 506 work now (3) how would the proposed amendments alter the effect of Rule 144A and Rule 506 (4) whether the proposed revision to Form D is necessary if one allows the proposed amendment to Rule 506 (5) if the amendments to Rule 506 and 144A are allowed, do they conform with the existing public policy rationales behind the rules and, (6) based on the totality of the information available, should these proposed amendments be promulgated?
II. THE JOBS ACT
Signed into law on April 5, 2012, the JOBS Act was created to encourage funding of small businesses within the United States by reducing the burden of various federal securities laws. Under Title II , Section 201(a)(1), the JOBs Act explicitly requires that: "not later than 90 days after the date of the enactment, the SEC shall revise its rules to provide that the prohibition against general solicitation or general advertisingshall not apply to offers and sales of securities, 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" Moreover, under Section 201(a)(2), the JOBs ACT also specifically requires that:"not later than 90 days after the date of enactment of this Act, the SEC shall revise , to provide that securities sold under such revised exemption may be offered to persons other than qualified institutional buyers, including by means of general solicitation or general advertising, provided that securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe is a qualified institutional buyer." A literal reading of the JOBs Act confirms that the SECs interpretation of its obligation to revise Rule 144A and Rule 506 D is presumptively correct. In order to comply with the JOBs Act, the proposed amendments appear to be required. Under the terms of 201, the SEC was required to implement the proposed changes not later than 90 days after the date of enactment of this Act. Intuitively, this means that the SEC was supposed to implement these changes no later than July 4, 2012. Despite this mandate, the July 2012 deadline has long since passed, and there still has been no action by the SEC to comply with the mandates of the JOBs Act 201.
The SECs inaction has potentially significant repercussions for the JOBs Act, and the securities market at large. Arguably, the JOBs Act itself, and the proposed amendments, function to increase capital formation and facilitate the growth of small enterprise, which we believe are crucial steps to jumpstarting economic recovery. However, the SECs inaction sends a less than positive message to the general public about the SECs appreciation of their obligations under the JOBs Act, and their willingness to implement changes in a timely fashion. While we are confident that the SEC does not want to undermine public confidence its responsiveness to legal mandates and has a significant interest in assisting in the revival of the economy. We would urge the SEC, without further delay, to implement the proposed amendments in order to be in compliance with 201 of the JOBs Act. With that in mind, the remainder of this comment addresses the practical impact of the proposed amendments, and the policy implications of implementing such changes.
What is the interplay of the JOBs Act and the 1933 Act 4(a)(2)?
Section 201(a)(1) of the JOBs Act highlights that the revisions pursuant to this section will continue to be treated as a regulation issued under 4(a)(2) of the 1933 Act. Currently, 4(a)(2) exempts certain transactions by an issuer not involving any public offering – i.e., the so-called private offering exemption. An issuer who relies on the 4(a)(2) exemption is thereby restricted in its ability to make public communications to attract potential investors for the offering of securities. Under the current state of the law, the availability of the 4(a)(2) safe harbor in Rule 506 offerings is predicated on adherence to a no general solicitation rule. If the proposed amendment to Rule 506 is finalized, it would functionally extend the safe harbor protection of 4(a)(2), by allowing for general solicitation offerings to accredited investors, or those investors that the issuer reasonably believes are accredited investors. This extension of the safe harbor has the potential to boost capital formation and aid in the overall recovery of the economy by facilitating the growth of small businesses. However, this begs the question: are the proposed amendments consistent with existing precedent? We do not believe so.
Does the interaction between the JOBs ACT and 4(a)(2) require that we modify how Ralston Purina works?
Recall that in SEC v. Ralston Purina Co., the court held that a corporation offering stock to "key employees" was still subject to 5 of the 1933 Act. The issue before the court was whether Ralstons offerings of treasury stock to its key employees were exempt under 4(2). The court found that Ralston was not exempt, and reasoned that the remedial purposes of federal securities law placed the burden of proof on Ralston to prove the applicability of the exemption, which it did not meet under the facts. In Ralston Purina, the court concluded that the employees were not shown to have access to the kind of information that a registration would disclose, and thus, the potentiality for undue pressure and influence would not allow for the exemption. In short, Ralston Purina stands for the proposition that the availability of the exemption stems from the knowledge of the offerees, rather than the motivations or actions of the issuer. The decision in Ralston Purina is seemingly inconsistent with the proposed amendments to Rule 506 and Rule 144A under the JOBs Act.
Under the proposed amendments to Rule 506 and Rule 144A, the focus is not on who is buying the securities, but rather, the actions and motivations of the issuer. If one starts with Ralston Purina and works forward, including the SECs preliminary notes, one reaches the inevitable conclusion that Ralston Purina is at odds with the mandates of the JOBs Act. The effect of the proposed amendment would be to shift the critical determination in applying the safe harbor from an inquiry relating to who the offeree is to whether the offeror engaged in bad faith conduct. In practical terms, this means that the ultimate inquiry involves the conduct of the offeror or issuer, rather than the status of the offeree. Thus, at least arguably, if the issuer acts in accordance with the requirements in the proposed amendments to Rule 506 and Rule 144A, then the status of the offeree is almost irrelevant. With this in mind, how should one reconcile these inconsistencies? The SEC should take the lead and clarify the state of the law before promulgating the proposed amendments.
What is the interplay between Rule 506 and 4(a)(2)?
Rule 506, as laid out in the preliminary notes, is not an exclusive provision, so if an issuer does not qualify, then, at least arguably, it could still have a fallback position in 4(a)(2). As such, this raises a series of troubling questions, including: (1) in the context of the JOBs Act, what does the existence of this fallback position really mean for Rule 506 (2) as previously suggested, is the fallback position as it relates to Rule 506 not simply further evidence that Ralston Purina is superseded by subsequent legislation and (3) how does one square the SECs position with that of the objectives of 4(a)(2)? At least intuitively, one possibility is to simply say that we follow the statute because it is established law. However, such a position is not necessarily consistent with the SECs stated goal of providing broad investor protections. More importantly, such a position does not solve the blowback problem of (4)(a)(2). For example, currently, an issuer who, for whatever reason, fails to meet the requirements to establish Rule 506 safe harbor protection, can then, in theory, claim the protections of 4(a)(2). Under this hypothetical, an issuer who fails to establish that it made a public offering or a general solicitation to an accredited investor, or someone whom it reasonably believed was an accredited investor, could then claim protections under 4(a)(2). This protection seems overly broad, and again, not necessarily in line with facilitating investor protections. As a result, the SEC should take the initiative to clarify the interplay of Rule 506 and 4(a)(2), possibly by revising the pertinent language of the preliminary notes to Regulation D, before finalizing the proposed amendments.
III. HOW DO RULE 144A AND RULE 506 FUNCTION UNDER CURRENT LAW?
Rule 144A
Rule 144A of the 1933 Act is a non-exclusive safe harbor exemption from registration requirements for resales of certain restricted securities to qualified institutional buyers (QIBs). These restricted securities are defined in Rule 144(a)(3) to include, in relevant part, securities acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a chain of transactions not involving a public offering.
Who are QIBs?
The 1933 Act defines QIBs as any of the following entities, acting for its own account or the accounts of other QIBs, that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entityany insurance company and any investment company Rule 144A states that to qualify for the exemption, an offer or sale must meet the following conditions: (1) the securities are offered or sold only to a QIB, or to an offeree or purchaser that the seller, and any person acting on behalf of the seller, reasonably believes is a QIB and (2) the seller and any person acting on its behalf takes reasonable steps to ensure that the purchaser is aware that the seller may rely on the exemption from the provisions of section 4 of the 1933 Act.
In determining whether a prospective purchaser is a QIB, the seller, and any person acting on its behalf, shall be entitled to rely upon the following non-exclusive methods of establishing a prospective purchasers ownership and discretionary investments of securities: (1) publicly available financial statements (2) publicly available information in documents filed by the prospective purchasers with the SEC or other federal, state, or local governmental agency or self-regulatory organization, etc. (3) publicly available information appearing in a reorganized securities manual and (4) a certification by the CFO, or other executive officer of the purchaser, etc. Other than this non-exclusive list, the rule does not further delve into the meaning of reasonable steps into determining if a prospective purchaser is a QIB. Assuming that a seller takes reasonable steps and determines that a prospective purchaser is a QIB, she or he can then claim the exemption, and proceed without filing a registration statement under 5.
Like accredited investors under Rule 506, QIBs are presumed to be sophisticated investors who possess a significant degree of knowledge and skill that would allow them to evaluate, and ultimately make an informed decision about, a particular investment opportunity. Such is the policy behind the exemption. The same rationale that speaks to accredited investors needing less procedural protections applies equally to QIBs. The SEC maintains that these proposed amendments will satisfy the requirements of the JOBS Act by increasing access to capital formation through public offerings, as well as ensuring that this ability is not used to sell securities to those who are not qualified to participate in such offerings.
Current Function of Rule 144A
Under existing law, the focus of Rule 144A is the status of the offeree. In determining whether an issuer qualifies for a safe harbor or whether an offer violates the securities laws, the operative moment is when the issuer makes the offer to the would-be offeree. This is the critical moment that the law uses to determine if a violation of securities laws has occurred, i.e., did the issuer fail to file a required registration statement, or alternatively, was the offeree bad, i.e., the offeree was not a QIB or the issuer did not take reasonable steps to ensure the potential investor was a QIB? Under the current formulation, either of these determinations would mean that the offer would be invalid and would not continue. Under current law, the function of Rule 506 safe harbor is similar to that of Rule 144A safe harbor.
Rule 506
Regulation D of the1933 Act was enacted in 1982 by the SEC to streamline and simplify the exemptions for limited offerings, i.e., to clarify those situations in which it is not necessary to file a registration statement. Regulation D had the effect of replacing former Rules 146, 240, and 242. Of relevant inquiry here are Rules 501 and 506. Simply stated, Rule 501 exists to define the terms used in Regulation D, most notably, those types of investors that qualify for the exemption.
Who Are Accredited Investors?
Of greatest interest here is the term accredited investor, which is defined in Rule 501 to mean any person who the falls within any of the following categories, or who the issuer reasonably believes falls within any of the following categories, at the time of the sale of securities to that person: "any bank, insurance company, registered investment company, business development company, or small business investment company an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million a charitable organization, corporation, or partnership with assets exceeding $5 million a director, executive officer, or general partner of the company selling the securities a business in which all the equity owners are accredited investors a natural person who has individual net worth, or joint net worth with the persons spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year or a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes."
The issue of what constitutes an accredited investor is paramount in any Regulation D inquiry because under Rule 506, an issuer can sell an unlimited amount of securities to an unlimited number of accredited investors, but must reasonably believe that each non-accredited purchaser, or his or her purchaser representative, as defined in Rule 501, has such personal knowledge or experience in financial and business matters that the purchaser representative is capable of evaluating the merits and risks of the prospective investment. If there are any non-accredited purchasers, the information required by Rule 502 must be provided to them. The policy rationale behind this rule is that accredited investors are presumptively more sophisticated, and thus, they do not need the same level of protection that securities law affords non-accredited investors. This protection usually comes in the form of issuer disclosure obligations, and a prohibition against general solicitation and general advertising by the issuer of the securities. The above definitional concerns are highly relevant, and ultimately critical, to the current function of Rule 506.
Current Function of Rule 506
Rule 506 is considered a safe harbor provision for the so-called private offering exemption of 4(2) of the 1933 Act. Rule 506 has a list of safe harbor requirements that, if met, are designed to ensure a company that it is within the Section 4(2) exemption. For example, the list includes, in relevant part, admonishments that the company: (1) cannot use general solicitation or advertising to market the securities (2) may sell its securities to an unlimited number of "accredited investors" and up to 35 other purchases and (3) must decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws. Moreover, while companies using the Rule 506 exemption do not have to register their securities, and usually do not have to file reports with the SEC, they must still file "Form D after they sell their securities, which provides a brief notice that includes the names and addresses of the companys owners and stock promoters, but contains little other information about the company.
IV. HOW WOULD THE PROPOSED AMENDMENTS ALTER THE EFFECT OF RULE 144A AND RULE 506?
Proposed Amendments to Rule 144A
The SEC proposes to revise Rule 144A(d)(1) of the 1933 Act to provide that the securities sold pursuant to Rule 144A may be offered to persons other than QIBs, including by means of general solicitation, provided that securities are sold only to persons that the seller, and any person acting on behalf of the seller, reasonably believes are a QIB. This proposal would amend Rule 144A(d)(1) to eliminate the references to offer and offeree, and instead, would require only that the securities are sold to a QIB, or to a purchaser that the seller reasonably believes is a QIB. Moreover, this would allow resales of securities under Rule 144A using general solicitation, so long as the purchasers are limited to QIBs.
The effect of the proposed amendment would be to shift the critical determination in applying the safe harbor from an inquiry relating to who the offeree is to whether the offeror engaged in bad faith conduct. In real world terms, this would mean that the concern would be with the conduct of the offeror or issuer, rather than the status of the offeree. The proposed amendment seems concerned with the conduct of the offerer in relation to the lifting of the prohibition on general solicitation. For example, if the issuer determines that the potential investor is a QIB, or at the very least, makes a good faith effort to determine the potential investors status as a QIB, then she or he will qualify for the safe harbor protection. One of the most significant shortcomings of the proposed amendments is that the SEC proposal neither specifies what constitutes a good faith effort to determine if an investor is a QIB, nor does it provide safe harbor steps that, if taken, would assure issuers and investors of the availability of the exemption. For claritys sake, this is something that the SEC should seriously consider revising before finalizing the proposed amendment. The proposed amendment would functionally extend the safe harbor protection, and would, at least in theory, not invalidate the underlying offer or sale, which would have presumptively been the outcome under the current rule. In this way, the proposed amendment has significant implications for both issuers and potential investors.
Proposed Amendments to Rule 506
Fundamental Changes and Policy Rationales
The proposed amendment to Rule 506 would provide that the prohibition against general solicitation and general advertising contained in Rule 502(c) of Regulation D would not apply to offers and sales of securities made pursuant to Rule 506, provided that all purchasers of the securities are accredited investors. The proposed amendment to Rule 506 would also require that, in Rule 506 offerings that use general solicitation or general advertising, the issuer take reasonable steps to verify that purchasers of the securities are accredited investors. As previously mentioned, the question is basically whether the SEC considers accredited investors to be in need of increased safeguards in connection with the sale of securities. Arguably, at least historically, the answer is no. As the definition in Rule 501(a) illustrates, accredited investors are generally highly sophisticated entities. It is generally understood that an accredited investor is presumed to possess particular knowledge and experience in financial and business matters such that she or he is capable of evaluating the merits and risks of any prospective investment. It seems reasonable that these sophisticated investors would require less administratively imposed procedural safeguards thus, the SECs proposed amendment in the context of Rule 506 and accredited investors, at least at first glance, seems consistent with existing policy understandings.
Qualifying for Rule 506 After Amendments
In order for an issuer to qualify for general solicitation and advertising under the amended Rule 506, the JOBS Act requires that the issuer take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission. Thus, the SEC would be responsible for establishing methods of compliance, in order to ensure that issuers take such reasonable steps. By its own admission, the SEC construes the reasonableness standard in 201 of the JOBs Act to be fairly flexible, and guided by several factors, i.e., the type of purchaser the accredited investor claims to be, the amount of information the issuer has about the purchaser, and the nature of the offering and the manner in which the purchaser was solicited. At least presumptively, these procedures should be established prior to finalizing the proposed amendments, in order to ensure uniform compliance. However, the SEC has yet to establish clearly what constitutes reasonable steps. Thus, leaving issuers devoid of clearly established standards that would allow them to engage in a general solicitation under Rule 506. As a matter of good public policy, there should be clearly defined guidelines for invoking the safe harbor, which would provide both issuers and potential investors with certainty as to the applicability of the exemption. For sake of clarity and administrative ease, the SEC should consider clarifying its position on what constitutes reasonable steps before finalizing the proposed changes.
Expanding the Existing Safe Harbor
As with the Rule144A proposed amendment, the proposed change to Rule 506 would also have the impact of expanding the existing safe harbor. As with Rule 144A, there would be a shift in focus to the actions of the issuer. The inquiry would center on whether the issuer, in claiming a Rule 506 exemption, took the necessary steps to ensure that she or he sold to an accredited investor or someone who, after taking reasonable steps, was believed to be an accredited investor. This proposed amendment allows for the possibility that a sale or offer to a non-accredited investor would be allowed to move forward so long as the issuer initially made a good faith effort by taking reasonable steps. As previously noted, one of the glaring shortcomings of the proposed amendments is the lack of specific guidelines as to what constitutes reasonable steps. That aside, assuming applicability of the exemption, the practical implications are potentially significant. Under the current law, which focuses on the status of the offeree, the underlying offer would almost certainly be invalidated however, under the proposed law, it is quite possible that the underlying offer would still be allowed. Thus, just as with Rule 144A, the proposed amendment has significant practical implications for both issuers and investors.
Bifurcated Rule 506 Offerings?
A more nuanced complication would arise if the SEC finalizes the amendment to Rule 506, as it would seemingly create a complicated, bifurcated offerings system. In proposing the 506(c) amendment to allow for an exemption for general solicitation, the SEC notes that it preserved in Rule 506(b), the ability of issuers to conduct Rule 506 offerings without the use of general solicitation. The SEC maintains that this shows an understanding of the intricacy of securities transactions, and acknowledges that some issuers rely on Rule 506 as an important source of capital and that they may not be interested in engaging in a general solicitation, and in the process, becoming subject to a heightened standard requiring taking reasonable steps to verify accredited investor status. However, in practical terms, this only seems to complicate matters, because under the finalized amendment there would be two different types of Rule 506 offers – those that utilize general solicitation and those that do not. In real world application, this seems like a significant oversight on the part of the SEC. Arguably, having a bifurcated offering system within the same rule would create an administrative nightmare, as it might often be difficult to tell, without explicit explanation to the contrary, whether an issuer is claiming the exemption and safe harbor, or whether they are not and are simply engaging in standard Rule 506 offering. If the SEC hopes to proceed with the proposed amendment to Rule 506, then it must address this bifurcation issue, as the overwhelming lack of clarity threatens to undermine some of the potential benefits of the proposed amendments.
V. PROPOSED REVISION TO FORM D
The SEC is proposing to amend Form D to add a check box to indicate an offering relying on the Rule 506(c) exemption. Historically, Form D was adopted as part of the establishment of a series of exemptions for offers and sales of securities under the 1933 Act, and would require disclosure of certain information relating to the issuer, related persons, and the offering itself, which would be required for ultimately implementing the claimed exemptions and monitoring their use. In the interests of continuity and clarity, the proposed amendment to Form D is reasonable and should be implemented. That said, from a practical perspective, it is less clear whether such a revision to Form D would actually provide markedly increased efficiency. The SEC maintains that the proposed revision would have a negligible effect on the paperwork burden. This is an entirely reasonable position to take. Merely adding a check box for issuers to indicate whether they are claiming an exemption is purely an administrative change with no real burdensome implications. In fact, the information collected by Form D would be substantially the same but for the addition of a small check box thus, the additional information collected is minimal at best.
An argument can be made that the revision would both serve as notice of the issuers intent to claim the Rule 506 exemption, and potentially assist in streamlining the administrative process. However, does this mean that the SEC is to take issuers at their word that they qualify for the exemption? Presumably, the SEC would have no reason to inquire into the Form D filings unless subsequent litigation arose as to whether the issuer actually qualified for the Rule 506 exemption. Thus, the addition of the Form D checkbox could lead to increase instances of fraud however, it is plausible that this concern is adequately addressed by the already existing 18 U.S.C. 1001, which serves to prevent transmission of fraudulent information to the government. More time is probably needed to assess whether this theory actually holds true, but at least for now, it is reasonable to assume that a small administrative change to Form D would not exponentially increase the instances of fraud. That said, because the SEC suggests that the proposed amendment to Rule 506 will lead to increased Form D filings, it logically follows that this seemingly small, but potentially useful, administrative change to Form D is warranted.
VI. PUBLIC POLICY CONSIDERATIONS
Overview
The practical and policy implications of the SECs proposed amendment to 144A are significant. Rule 144A currently provides a non-exclusive list of ways to establish whether a buyer is a QIB. Historically, the 1933 Act was concerned with preventing fraudulent or deceptive practices in connection with the offer and sale of securities. Likewise, the 1933 Act was concerned with providing varying levels of protection to potential buyers of securities depending on their respective levels of sophistication. Often times, the more sophisticated the buyer, the less concerned the SEC has been with providing additional procedural safeguards. As a general rule, it seems far less likely that a would-be issuer is going to engage in fraudulent or deceptive practices with a more sophisticated buyer, for fear that the buyer would be able to detect the dishonest practices. The alternative is also true. In those situations where would-be issuers engage in fraudulent or deceptive practices, logically, it seems that they are more likely to do so with a buyer whose level of sophistication is such that it would not easily detect dishonest practices. In light of this, it makes sense why the SEC places additional safeguards for certain kinds of transactions.
There are arguably significant benefits for both issuers and potential investors in eliminating the prohibition against general solicitation in rule 506 and rule 144A offerings, and in doing so, extending the safe harbor protections to issuers.
Rule 506 of Regulation D and Rule 144A of the 1933 Act
Arguably, the proposed amendment to Rule 506 has the potential to increase the total number of Regulation D filings because of the expanded safe harbor protections and the potentiality for increased profits. By allowing issuers to engage in general solicitation, it affords the potential to reach a greater number of potential investors, thus increasing total revenue potential. General solicitation arguably will make it easier for issuers to find qualified accredited investors, thus reducing search costs and enhancing efficiency. An argument can be made that there will also be an increase in competition among investors because the volume of investors would potentially rise, thus potentially resulting in reduced costs for issuers.
On the other hand, the SEC contends that the proposed amendment to Rule 144A is not likely to afford issuers any meaningful benefit, as it would with Rule 506 offerings, because the number of QIBs is generally lower than that of accredited investors, as they are often known by market participants, and are better networked. However, simply because the economic benefits are not substantial does not mean that the proposed amendment is any less meritorious. The use of general solicitation still affords the potential for issuers the ability to reach investors more directly, thus eliminating the need for a middle man, which could easily result in substantial savings for issuers.
On a broader scale, there are other significant benefits as well. However, perhaps a more meaningful inquiry into the potential benefits of the proposed amendments can be observed in comparing the potential issuer benefits with the potential investor benefits.
Issuer Benefits
One of the most important advantages to the proposed SEC amendments is the potential for eliminating issuer uncertainty in the offering or sale of certain securities. One of the biggest issues with modern day securities law is the alarming complexity of applicable statutes and rules. The SECs proposed amendments can be viewed as a step towards simplification. The proposed amendments would provide issuers with a heightened degree of certainty in their dealings with either accredited investors of QIBs, and will undoubtedly reduce the fear of punishment due to non-compliance.
Moreover, the proposed amendments do not place unreasonable expectations on issuers. The proposed amendments only require that the issuer reasonably believe someone is an accredited investor or a QIB. The proposed amendments do not require absolute certainty, but instead are drafted to account for the possibility of human error. The SEC recognizes that even with precautions and reasonable efforts on the part of issuers, mistakes are still made. The extension of the safe harbor provisions is merely a logical reaction to this reality.
Investor Benefits
As with issuers, the SECs proposed amendments are likely to afford investors benefits as well. The proposed amendments are likely to address investment difficulties, i.e., the inability of investors to find opportunities in Rule 506 offerings. The proposed amendments, and the allowing of general solicitation, would likely make it easier for potential investors to identify a potentially larger and more diverse pool of investment opportunities. Moreover, there is also an increased likelihood that potential investors would receive an increased flow of information about issuers and their offerings that would not have previously been made publicly available prior to the proposed amendments. Thus, the elimination of the prohibition against general solicitation would also arguably reduce the cost to potential investors in gathering information about issuers and potential offerings. This less expensive information flow could ultimately lead to more efficient offerings, which I believe to be highly beneficial. As such, we generally believe the SECs amendments are grounded in good public policy, a solid understanding of the law, and are proposed with practical economic and social realities in mind. However, there are some glaring downsides to the propositions.
Doorclosers, Inc. recognize that there are potential downsides to eliminating the prohibition against general solicitation in Rule 506 and Rule 144A, but maintain that the aforementioned benefits ultimately compel implementation of the proposed amendments to Rule 506 and Rule 144A offerings.
For the SEC, the concern for fraudulent schemes is always at the forefront of the debate. There is an argument to be made that eliminating the prohibition against general solicitation could potentially make it easier for promoters of fraudulent schemes to reach potential investors through public solicitation and other methods that would have been previously prohibited. The end result would undoubtedly be costly lawsuits that would only serve to undermine investor confidence in Rule 506 and Rule 144A offerings. Lowered investor confidence could result in a decreased potential for capital gain, and ultimately, decreased efficiency. While this is a very real concern, it is important to note that this risk of fraudulent behavior might be mitigated to some extent by the Rule 506 sale limitation to accredited investors, and alternatively, the Rule 144A sale limitation to QIBs. Generally, both accredited investors and QIBs are highly sophisticated investors that are better equipped to make informed decisions about investments, and thus, are less likely to fall victim to fraudulent schemes. Likewise, it is equally possible that in engaging in general solicitations that would-be fraudulent issuers may be more hesitant to undertake fraudulent activity due to its public nature, and the increased potential for detection by the SEC. Moreover, as always, issuers would still be subject to the extensive antifraud provisions, which provide yet another layer of protection and deterrence, and which help to ease general fraud concerns. As such, although there are potential downsides to the proposed amendments, we believe the benefits are significantly more compelling.
VII. CONCLUSIONS
For the aforementioned reasons, it is the position of Doorclosers, Inc., and our affiliates, that the SECs proposed amendments to Rule 506, Rule 144A, and Form D, are mandated by the JOBs Act 201, should be revised as suggested, and then finalized without further delay. Any further inaction runs the risk of seriously undermining public confidence in the SEC. Moreover, failure to implement the proposed amendments raises troubling questions regarding the SECs appreciation of its obligations under the JOBs Act, and its willingness to implement changes in a timely fashion. Likewise, under a strict reading of the JOBs Act, the SEC has a legal mandate to implement such changes, and is long overdue in doing so. In general, the SEC has a significant interest in assisting in the revival of the economy, which is an explicit goal of the JOBs Act. The benefits of increased information flow, reduced costs, potential increased capital growth, and heightened efficiency outweigh concerns regarding potential fraudulent practices and other issues, given the other antifraud safeguards already in place. Thus, simply stated, the SEC, without further delay, should finalize the proposed amendments in order to be in compliance with 201 of the JOBs Act.