Too Little, Too Late: The SEC attempts to enact the JOBS Act

The SEC has finally taken action on the JOBS Act, passed in April, 2012.  The JOBS Act requires the SEC to amend Rules 506, and 144A of Regulation D of the Securities act of 1993.  Rule 506 contains a provision prohibiting the “general solicitation or general advertising” by issuers trying to sell securities.   Rule 144A has the same effect on resellers of securities, prohibiting general advertisement or solicitation.  The proposed rule amends these Rules by removing the provision against general solicitation or advertisement.  As issuers generally use the sale of securities to raise capital, the goal is to stimulate business by reducing the regulations and making it easier for issuers and resellers to find buyers.

On the surface these amendments would appear to be an excellent way to stimulate company growth and development, but a look closer at the proposed rule shows that rather than clearing the way for securities solicitation and advertisement, the SEC is muddying the waters.  While, under the amended Rule 506, an issuer would be able to make general solicitation and advertisements to offer and sell securities, there are a number of conditions that must be met first.  “The issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors; and (a)ll purchasers of securities must be accredited investors, either because they come within one of the enumerated categories of persons that qualify as accredited investors or the issuer reasonably believes that they do, at the time of the sale of the securities.”

The issuer, then, would be allowed a general solicitation, but not a general sale, as any proposed purchaser would have to qualify as an “accredited investor” before the sale could be made.  The burden of determining whether the purchaser qualifies is on the issuer, who must take “reasonable steps” to determine the purchaser’s qualifications.   The SEC does not state what reasonable steps might be, but instead provide “a number of factors when determining the reasonableness of the steps to verify that a purchaser is an accredited investor.”  These factors include “(t)he nature of the purchaser and the type of accredited investor that the purchaser claims to be… (t)he amount and type of information that the issuer has about the purchaser; and,…(t)he nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering.”

The SEC even acknowledges that investigating these factors may be difficult and even raise privacy and disclosure issues when dealing with natural persons as buyers.  While the removal of these restrictions on the solicitation and advertisement of the sale of securities should promote business growth, this rule still requires the issuer to investigate each proposed buyer to the extent that there is little to no difference between general and specific solicitation.  Additionally, without more information on what the SEC considers “reasonable methods,” (the SEC specifically declines to offer even a suggested list) issuers could put themselves at risk, if the methods they use are decided to be unreasonable.

Exactly how this proposed rule will affect issuers and, ultimately, the economy remains to be seen, but, in its current form, it makes things more complicated for issuers trying to solicit buyers, rather than simplifying and streamlining the process, as was the intention of the JOBS Act.