The Jumpstart Our Business Startups Act of 2012 (JOBS Act) requires that the SEC amend Rule 506 of Regulation D to permit general solicitation and advertising in private placements as long as all purchasers are accredited investors. This change has the potential to significantly alter the way in which capital is raised by start-ups, operating businesses and private funds. This article discusses the current status of the JOBS Act mandated changes to Rule 506 (506 Advertising Rules).
The JOBS Act was signed into law on April 5, 2012. It requires that the SEC make these changes to Rule 506 by July 4, 2012. This timeframe has proven unrealistic.
The SEC opened its website to comments on these provisions before actually proposing regulations to implement the 506 Advertising Rules. Click here for a summary of the comments the SEC received before it proposed the rules.
Relatively quick action was anticipated by some commenters when the SEC scheduled a meeting on Aug. 22, 2012 to vote on the 506 Advertising Rules. Reports published before this meeting stated that the SEC would adopt a temporary rule implementing these JOBS Act provisions. These reports generated a lot of controversy, and many comments to the SEC sought to convince the SEC not to take this approach. The SEC deferred action on the 506 Advertising Rules to Aug. 29, 2012, apparently for the purpose of changing the item from an interim rule to a proposed rule change.
As anticipated, the SEC proposed rule changes on Aug. 29, 2012 (Proposed 506 Advertising Rules), rather than adopting an interim rule.
The SEC’s decision to propose the Proposed 506 Advertising Rules instead of adopting an interim rule resulted in numerous comments and significant acrimony at the Commission level. This action also triggered a request for documents relating to the preparation of the Proposed 506 Advertising Rules from the subcommittee of TARP, the Financial Services and Bailouts of Public and Private Programs of the House Committee on Oversight and Government Reform. The Chairman of this Subcommittee, Patrick McHenry (R N.C.) expressed dismay that the interim rule was not adopted, and that there would be a delay in implementing the 506 Advertising Rules.
The Proposed 506 Advertising Rules have generated significant comments and continued controversy.
The SEC proposed a flexible approach to the verification of accredited investor status. However, the Proposed 506 Advertising Rules did not contain much in the way of investor protections. Though the comment period for the Proposed 506 Advertising Rules ended on Oct. 5, 2012, the SEC has continued to receive comments and hold meetings with interested parties after the end of the comment period.
Most industry participants, bar association committees and some individuals supported the SEC’s flexible approach to verification. Trade associations representing hedge funds or private equity funds generally supported the proposal, as did a number of Republican legislators.
A wide variety of those supporting the Proposed 506 Advertising Rules also supported revising the rule to include non-exclusive safe harbors for verification.
However, a large number of individuals, investor and consumer advocates, state securities regulators and Democratic legislators opposed the proposal and advocated significantly enhanced investor protection.
Changes at the SEC Cause Further Delay
The Chairman of the SEC, Mary Shapiro, resigned in late November 2012 effective Dec. 14, 2012. This resignation left the Commission with four commissioners. So far, the remaining commissioners have not reached agreement on a path forward for the changes to Rule 506 required by the JOBS Act.
In December 2012, we distributed a summary of the comments on the Proposed 506 Advertising Rules through Dec. 7, 2012. Our news item also included a discussion of the proposed rule itself, concerns relating to the proposed rule, the impact of the resignation of former Chairman Shapiro on the rulemaking proceeding, and the positions of the remaining four commissioners on the proposed rule. Click here for access to our previous item.
The SEC has continued to receive comments on the Proposed 506 Advertising Rules. As of March 22, 2013, the SEC has received 32 additional comments since Dec. 7, 2012. The comments mostly consist of emails complaining about the failure of the SEC to adopt the proposed rule changes. A number of these comments have been submitted anonymously, with a significant percentage apparently having been submitted by one person who calls himself/herself “Anonymous Anonymous.”
Many of these comments are extremely critical of the SEC and former Chairman Shapiro. For example, one commenter, Jason Coombs, said that “It is time for a competitor to the SEC to emerge in the marketplace.” He also opined:
“I believe that a private, for-profit company can do a better job of helping the Executive and Judicial branches of government with civil and criminal forensics than the SEC has done since 1934.” (Comment Dec. 19, 2012)
Some of the comments are even more caustic and sarcastic.
There have been a few comments with substantive content. For example, Ian R. Shuster, in a comment dated March 4, 2013, recommended that general solicitation be permitted only in media/venues where the audience can reasonably be expected to be sophisticated in financial matters.
In addition to receiving comments through its website, the SEC has also had several meetings with parties who have an interest in this rulemaking. The SEC's comment file on this matter shows 12 meetings after these changes were proposed, four during the comment period, five in 2012 after the comment period ended and three in 2013. The two most recent meetings are instructive. For example, on Jan. 17, 2013 Commissioner Paredes met with representatives of the Managed Funds Association. On Jan. 22, 2013 Chairman Walters met with representatives of Consumer Federation of America, Americans for Financial Reform, AARP, AFL-CIO, Public Citizen, Motley Fool, Demos, Council of Institutional Investors, AFSCME, LIUNA, SEIU and University of Denver School of Law. Several of the people who attended this meeting are also members of the SEC’s Investor Advisory Committee.
Potential Impact of the SEC’s Investor Advisory Committee
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which was signed into law in July 2010, among other things, created the Investor Advisory Committee. The Investor Advisory Committee consists of 21 people, with diverse backgrounds. The members of the Investor Advisory Committee include former SEC commissioners, representatives of institutional private and public investors, and consumer advocates, as well as others with important perspectives on securities matters.
The statutory purpose of the Investor Advisory Committee consists of advising and consulting with the SEC on issues relating to the regulation of securities and the protection of investors. It is also authorized to submit recommendations to the SEC.
On Oct. 12, 2012, the Investor Advisory Committee submitted recommendations relating to the Proposed 506 Advertising Rules. It recommended that:
- all issuers using general solicitation should be required to file either a new form (GS) or a revised Form D, as a precondition of using the exemption;
- all solicitation material should be furnished to the SEC;
- there should be a safe harbor with clear and enforceable standards for verification;
- the filing of Form D should be a condition of the use of general solicitation;
- performance claims used in general solicitations should be required to be based on appropriate performance reporting standards;
- the “natural person” prong of the accredited investor definition should be changed to better reflect financial sophistication; and
- the provisions required by Dodd-Frank that disqualify felons and other “bad actors” from using Rule 506 should be adopted.
The minutes of the Oct. 12, 2012 meeting of the Investor Advisory Committee at which these recommendations were adopted, and an audio recording of the meeting, are available on the SEC’s website. Click here for a link to these materials.
On March 22, 2013 the Managed Funds Association (MFA) responded to the recommendations of the SEC’s Investor Advisory Committee. Although this letter states that the MFA supports the idea that the filing of Form D should be a condition of general solicitation, the MFA letter states that it opposes a pre-filing requirement. As a result, the practical impact of the MFA position is to oppose the recommendation. The MFA also opposed the addition of further required disclosure in Form D for advertised offerings, any requirement to file advertising material with the SEC, any regulation of performance information, and the amendment of the natural person accredited investor standard.
The MFA supported the recommendation that the “bad actor” provisions be adopted in conjunction with the this rulemaking, but included several suggested changes to the proposed “bad actor” rules.
On verification of accredited investor status, the MFA supports a minimum investment test ($500,000 for individuals and $2.5 million for entities) and self certification plus confirmation of accredited status from one third party source if these minimum investment tests are not met.
The recommendations of the Investor Advisory Committee go to the heart of the approach taken in the Proposed 506 Advertising Rules. The SEC proposal did not require the filing of a Form D as a condition of general advertising nor did it require the filing of advertising materials. The proposed rule did not include a safe harbor and was flexible on the verification procedure. In addition, the proposed rule changes did not include any requirements relating to the content of performance advertising. A number of the members of the Investor Advisory Committee submitted their own comment letters on the proposed rule changes, including several consumer and investor representatives. The recommendations of the Investor Advisory Committee endorse suggestions made by a number of these and other investor advocates as well as state securities regulators, as opposed to the approach generally supported by representatives of the private fund industry.
When the Investor Advisory Committee submits recommendations, the statute that created the body requires the SEC to review those recommendations and to issue a public statement assessing them and stating the action the SEC intends to take. Because the statute seems to require that the SEC specifically address comments of the Investor Advisory Committee, the Oct. 12, 2012 comments of the Investor Advisory Committee may be in a somewhat different position than the comments of others. In a written statement presented at a Jan. 18, 2013 Investor Advisory Committee meeting, Commissioner Aguilar noted the recommendations of the Investor Advisory Committee regarding the Proposed 506 Advertising Rules and pointed out the statutory requirement for the SEC to respond to them.
Impact of a New SEC Chairman
As we predicted in our Dec. 12, 2012 summary, nothing has happened on the Proposed 506 Advertising Rules, and the outcome will probably be driven largely by the approach of the new SEC chairman.
President Obama has nominated Mary Jo White to be the new SEC chairman. White is a former U.S. Attorney for the Southern District of New York and partner at a Wall Street law firm.
In prepared testimony made public on March 11, 2013, White stated that she would work with the SEC staff and the other four commissioners to finish “in as timely and smart a way as possible” the Dodd-Frank and JOBS Act rulemaking. However, her statement does not take a position on the approach that should be taken on the Proposed 506 Advertising Rules.
White took a similar approach at the confirmation hearing that was held on March 12, 2013, promising quick action, but not advocating any particular resolution of the impasse on the Proposed 506 Advertising Rules.
The Senate Banking Committee cleared the nomination of White on March 19, 2013 and she is expected to be confirmed.
If White sides with the Investor Advisory Committee and Commissioners Walters and Aguilar, we believe that changes to the Proposed 506 Advertising Rules will probably be revised and reproposed. However, if she sides with Commissioners Gallagher and Paredes, then the Proposed 506 Advertising Rules will probably be adopted as proposed.
It is also possible that some of the changes advocated by opponents of the Proposed 506 Advertising Rules will be made and that the rule will be adopted with those changes on either a permanent or temporary basis.
In any case, it can be expected that many of the same people who have already expressed their views directly to SEC Commissioners or to the SEC staff will seek to meet with Chairman White and present their perspective to her.
As indicated in the title of this article, when confirmed, the new SEC chairman will get this ball rolling again. The only questions are how fast and in which direction.