Advertised Private Placements: Will the SEC Adopt An Interim Rule or Re-Propose the Rule?

May 28, 2013

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 (506 Advertising Rules). This change has the potential to significantly alter the way in which capital is raised by start-ups, operating businesses and private funds.

With a new Chairman, Mary Jo White, the SEC is in a position to move forward on the 506 Advertising Rules.

The issue now facing the SEC is whether to adopt the 506 Advertising Rules, proposed last year, or to revise and repropose them.


The JOBS Act was signed into law on April 5, 2012. It required that the SEC make these changes to Rule 506 by July 4, 2012. This timeframe proved unrealistic and the required changes have not yet been made.

The SEC opened its website to comments on these provisions before actually proposing regulations to implement the 506 Advertising Rules. Click here for our summary of the comments the SEC received before it proposed the rules.

When the SEC scheduled a meeting on Aug. 22, 2012 to vote on the 506 Advertising Rules, several reports stated that the SEC would adopt a temporary rule implementing these JOBS Act provisions. These reports generated a lot of controversy, and ultimately the SEC deferred action on the 506 Advertising Rules to Aug. 29, 2012, changing its approach of adopting an interim rule to a proposed rule change.

As expected by then, the SEC proposed rule changes on Aug. 29, 2012 (Proposed 506 Advertising Rules), rather than adopting an interim rule. The Proposed 506 Advertising Rules have generated significant comments and continued controversy.

The Proposed 506 Advertising Rules

The SEC proposed a flexible approach to the verification of accredited investor status. However, the Proposed 506 Advertising Rules did not contain any significant new investor protections in this respect. This perceived lack of investor protection and other aspects of the Proposed 506 Advertising Rules generated many comments and 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 on this issue and others.

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 large number of those supporting the Proposed 506 Advertising Rules from almost all categories of commenters 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.

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 and concerns relating to the proposed rule. Click here for access to our previous item.

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 is to advise and consult 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.

The recommendations of the Investor Advisory Committee, if followed, would make significant changes in the Proposed 506 Advertising Rules and provide a much greater degree of investor protection. On March 26, 2013, we distributed a news item which discussed the status of the Proposed 506 Advertising Rules and included an explanation of the recommendations of the Investor Advisory Committee. Click here for access to our March 26, 2013 news item.

When the Investor Advisory Committee submits recommendations, the statute that created this 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. 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.

Current Status

As we mentioned, the SEC has continued to receive comments on the Proposed 506 Advertising Rules. As of May 22, 2013, the SEC has received 242 comments on the Proposed 506 Advertising Rules.

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 most recent meeting is instructive.

On April 23, 2013, Barbara Roper, director of Investor Protection for the Consumer Federation of America, met with Chairman White and several other SEC staff members. At the meeting, Ms. Roper presented a letter from representatives of the Consumer Federation of America, Americans for Financial Reform and the AFL-CIO. The letter, in effect, takes the position that the Proposed 506 Advertising Rules should be reproposed, incorporating the changes recommended by the Investor Advisory Committee.

On April 29, 2013, Ms. Roper, and others, sent a comment letter that also took the position that the Proposed 506 Advertising Rules should be revised to include the new recommendations of the Investor Advisory Committee, and be reproposed. In addition to Ms. Roper and several other investor advocates, this letter was signed by representatives of the crowd funding industry and former SEC Commissioner Wallman.

On May 15, 2013, Mercer Bullard, president of Fund Democracy, and Ms. Roper sent a comment letter to the effect that a study cited in the letter shows that “hedge funds routinely inflated their performance, apparently for the purpose of enticing new investors.” The comment letter takes the position that the SEC should conduct a cost benefit analysis of the impact of permitting unregulated advertisements and encourages the SEC to repropose the Proposed 506 Advertising rules in a way that deals with these potential costs to investors.

Impact of the Bad Actor Provisions

There is another consideration that may bear on timing. Dodd-Frank requires the SEC to enact provisions that deny the use of Rule 506 to people who have had securities law violations. The SEC proposed these changes in May 2011, but has not finalized them. There are several complex issues involved in determining the scope of these provisions, as well as whether the inability to use Rule 506 will be a consequence of securities law violations that took place before Dodd-Frank was adopted.

Virtually all investor advocates have taken the position that these “bad actor” provisions should be finalized before the Proposed 506 Advertising Rules are finalized. It is probable that there is support for this view among some members of the SEC staff, and at least one SEC commissioner.

There is a basis for this position. In the absence of the “bad actor” provisions, persons with securities law violations could publicly solicit Rule 506 investments.

Congressional Oversight

The slower than expected pace of implementation of the JOBS Act has generated a number of responses in Congress.

The SEC’s decision to move forward with the Proposed 506 Advertising Rules rather than adopting an interim rule resulted in the SEC being required to produce documents relating to this rule making to Congress. Representative McHenry ((R-N.C.) later released documents obtained in that production intended to show that in August 2012 Chairman Shapiro had been influenced by concerns over her legacy after a call from Ms. Roper, who is mentioned above, to change direction from an interim rule to the Proposed 506 Advertising Rules.

Recently, Congress held two hearings on the status of the JOBS Act implementation. In the first, on April 11, 2013, two senior SEC staff members testified before the Investigations, Oversight and Regulations Subcommittee of the House Committee on Small Business, but did not provide any specific anticipated dates for action on the unfinished JOBS Act matters.

On April 16, 2013, Commissioner Walter testified before the Oversight and Investigations Subcommittee of the House Committee on Financial Services concerning the failure of the SEC to fully implement the JOBS Act in a timely manner. In this hearing, several Republican legislators used documents that had been obtained in the document production described above for, among other things, raising the issue whether the SEC could enforce the ban on general solicitation after July 4, 2012, the date on which the JOBS Act required the SEC to revise Rule 506 to remove the ban where all investors are accredited. However, Commissioner Walter did not see this issue as serious. The questioning by various Republican legislators could be fairly described as hostile and sarcastic.

The status of and prospects for JOBS Act rulemaking were also the subject of recent House testimony by Chairman White in hearings relating to the SEC’s budget request. This testimony is discussed below.

The bottom line is that Congress is putting significant pressure on the SEC with respect to this topic.

The New SEC Chairman Will Determine the Approach

As the SEC determines its next step, the outcome will be driven largely by the approach of the new SEC Chairman, Mary Jo White.

The public statements by Chairman White have not taken a position on a specific next step for the Proposed 506 Advertising Rules.

In prepared testimony made public on March 11, 2013, Chairman 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 did not take a position on the approach that should be taken on the Proposed 506 Advertising Rules.

Chairman White took a similar approach at the confirmation hearing that was held on March 12, 2013. At that hearing, she promised quick action, but did not advocate any particular resolution of the impasse on the Proposed 506 Advertising Rules.

Chairman White followed this same path in testimony before the House Financial Services Committee on May 16, 2013, concerning the SEC’s budget request.

As is discussed above, several investor advocates have recommended that the SEC revise and repropose the Proposed 506 Advertising Rules. This recommendation has at times seemed to have included a threat of litigation if the SEC does not take this course. Among other things, investor advocates have asserted that failure to repropose the Proposed 506 Advertising Rules would violate the Administrative Procedures Act, a position possibly supported by Commissioner Aguilar.

Commissioner Aguilar has also stated publicly that the Proposed 506 Advertising Rules should be reproposed. In an April 16, 2013 speech to the Annual North American Securities Administrators Association Conference, Commission Aguilar stated as follows:

“The Commission received comments, both before and after the proposal, urging that we consider various amendments, alternatives, and recommendations to better align the mass-marketing provisions with investor protection. Yet, in a departure from the Commission’s standard practice of allowing proposals to include a fulsome discussion of reasonable alternatives, the proposing release did not request comment on any of those recommendations and, contrary to the Commission staff’s own guidance for economic analysis, the proposing release did not consider whether including any of the recommendations would be a reasonable alternative to the approach in the proposed rule. In addition, some may argue that under the Administrative Procedures Act this failure may prevent the Commission from even considering any of those suggestions unless there is a re-proposal. In all my time at the Commission, I’ve never seen a more aggressive effort to exclude pro-investor initiatives.”

“Because of the decision to ignore the recommendations by investors and other regulators, I consider the Commission’s proposal to be fatally flawed. . .”

“In my view, the only viable alternative is for it to be re-proposed so that we can provide for a fulsome discussion of how best to allow general solicitation under Rule 506 while, at the same time, considering the needs of investors. To me, it is clear that Congress did not expect the SEC to ignore investor protection issues. Instead of enacting a self-implementing provision to allow general solicitations, Congress gave the SEC the obligation to determine how best to do so. A re-proposal that allows for a real discussion of reasonable alternatives is the only path forward that will adequately address investor protection issues….”

(Emphasis added and footnotes omitted).

Commissioner Walter’s position is less clear than that of Commissioner Aguilar. Commissioner Walter voted in favor of the Proposed 506 Advertising Rules, but expressed dissatisfaction with some elements of the proposal. Commissioner Walter has made a few public statements concerning the JOBS Act. Commissioner Walter has stated that she favors lifting the ban on general solicitation. It has been reported that Commissioner Walter believes that the SEC should consider the recommendations of the Investor Advisory Committee. It has also been reported that Commissioner Walter has stated that some of these recommendations can be dealt with in a separate SEC effort. While Commissioner Walter has testified before a House subcommittee about the implementation of the JOBS Act, she has not taken a public position on whether to repropose the rules.

If Chairman White sides with the Investor Advisory Committee and Commissioner Aguilar, we believe that the Proposed 506 Advertising Rules will be revised and reproposed.

There has been at least one public report that Chairman White intends to adopt the Proposed 506 Advertising Rules as an interim rule. This approach would be somewhat ironic, because an interim rule was very seriously considered last year. However, at the May 16, 2013 hearing mentioned above, Chairman White indicated in response to a question that she was aware that small business owners believe that the Proposed 506 Advertising Rules do not provide sufficient certainty on verification procedures. In any case, if Chairman White wishes to take the approach of an interim rule, Commissioners Gallagher and Paredes would likely provide the necessary votes.

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.

The SEC announced on May 15, 2013, that Lona Nallengara, who had been acting head of the SEC’s Division of Corporation Finance, would become SEC chief of staff. The SEC also announced that Keith Higgens would become the new head of the Division of Corporation Finance. These changes appear to be designed to drive the various pending rulemakings forward at a more rapid pace.

In addition, the White House announced on May 23, 2013 that President Obama had nominated two Senate aides to become SEC commissioners. If confirmed, Michael S. Piwowar, an aide to Sen. Mike Crapo (R – Idaho), would replace Commissioner Paredes and Kara M. Stein, an aide to Sen. Jack Reed (D – R.I.), would replace Commissioner Walter. Depending on the timing of these changes, new commissioners could impact the pace of this rulemaking.

As of May 24, 2013, no SEC meeting has been scheduled to consider either the “bad actors” provisions or the Proposed 506 Advertising Rules.