Tag: general solicitation

How Do State Regulators Really Feel About the JOBS Act?

The House of Representatives recently voted to pass The Jumpstart Our Business Startups (JOBS) Act (H.R. 3606), a collection of several bills focused on barriers to capital formation. I’m focused on the bill because of mostly because of the Access to Capital for Job Creators section that would override the ban on general solicitation and advertising under Regulation D.

I welcome some sensible changes to Regulation D because I find the ban a bit vague as part of the fundraising process. Private fund managers could use guidance from the SEC on what is allowed and what is prohibited by the ban.

On the other hand, knowing the general ban exists makes it easy to dismiss scams and spam spinning tales of possible investment opportunities. That unsolicited message is either a straight-up scam or a naive entrepreneur who thinks they can operate without competent advice. Either way you can easily dismiss the opportunity.

Another provision of the JOBS Act that I found interesting is the Private Company Flexibility and Growth Act. The main purpose is to raise the thresholds under Section 12(g)(1)(A) of the Exchange Act. Currently under that provision, private companies with more than 500 shareholders and a big stream of revenue effectively have to become public companies. That shareholder limit forced Google into going public and most recently is forcing Facebook to go public.

The centerpiece of the JOBS Act is the new crowdfunding platform. Currently, platforms like Kickstarter are prohibited from offering equity. Project sponsors have to ask for donations, offer schwag, or pre-sell products. All of which seems to work very well.

Commentators like William Carleton think the concept of crowdfunding will be great for entrepreneurs. The Wall Street Journal has a point-counterpoint this morning on crowdfunding:

Like most stuff coming out of Congress, even if the concept is good I think Congress is likely to screw up the drafting of the law.

That is my view of the JOBS Act. Most of the concepts are good, but the execution is poor. I think Congress is missing the balance between investor protection and access to capital. That opinion is shared by the North American Securities Administrators Association. Here is a snippet from an editorial by Jack E. Herstein, president of NASAA:

The most jobs this cleverly named bill may create are jobs for fraudsters, like the Nigerian scammers, penny-stock pitchers and Ponzi schemers already lurking behind the Internet to cloak their schemes.

The Senate is mulling over their version of these bills where it seems to have bi-partisan support. President Obama has also thrown his support to some of the concepts in the JOBS Act. It seem likely that something will pass. According to Talking Points Memo it looks like Senate Majority Leader Harry Reid is willing to trade support for the JOBS Act for approval of some judicial nominees.

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Amending the Ban on General Solicitation and Advertising

There seems to be some momentum for changes to the  Regulation D’s prohibition on advertising a private fund offering. The Managed Funds Association has asked the SEC to start a rulemaking and one of the SEC’s new advisory committees has also recommended a change.

The SEC’s new Advisory Committee on Small and Emerging Companies approved its first recommendation on January 6. It urged the Commission to “relax or modify” the restrictions under Reg D to permit general solicitation and advertising of private fund offerings, but only to accredited investors.

3. The Advisory Committee is of the view that the restrictions on general solicitation and general advertising prevent many privately held small businesses and smaller public companies from gaining sufficient access to sources of capital and thereby materially limit their ability to raise capital through private offerings of securities; and

4. The Advisory Committee is of the view that the investor protections afforded by the existing restrictions on general solicitation and general advertising are not necessary in private offerings of securities whereby the securities are sold solely to accredited investors.

In a petition filed with the SEC last week, the Managed Funds Association states eliminating the general and advertising solicitation ban would “promote investment and enhance economic growth,” add new transparency to hedge funds and free up resources the agency could reallocate.

The House has passed a bill that would eliminate the advertising. It still needs support and action from the Senate.

Personally, I find the current ban hard to deal with because of uncertainty about what you can and cannot do. On the other hand, a broad allowance of advertising would likely perpetrate fraud. Currently, if you see an ad to invest in a private company or unique investment opportunity, it’s a red flag that the offer could be a fraud.

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Lifting the Ban on General Solicitation

From a  securities compliance perspective, when you  see an advertisement or an email seeking capital for an investment opportunity there is most likely a problem. Now there is a bill in Congress that would change that view.

When selling a security, you need to register the security or find an appropriate exemption from registration. Most likely a private fund or an entrepreneur would try to fall under one of the exemptions under Regulation D. If the company is seeking over $1,000,000 they are prohibited from offering to sell the securities “by any form of general solicitation or general advertising“. Before asking someone to make an investment, you need to have a preexisting, substantive relationship.

“The types of relationships with offerees that may be important in establishing a general solicitation has not taken place are those that would enable the issuer (or a person acting on its behalf) to be aware of the financial circumstances or sophistication of the person with whom the relationship exists or that otherwise are of some substance and duration.” Mineral Lands Research & Marketing Corp., S.E.C. No-Action Letter, 1985 WL 55694 (Dec. 4 1985).

Representative Kevin McCarthy (R-CA) introduced the Access to Capital for Job Creators Act (HR 2940) which require the Securities and Exchange Commission to revise its rules to permit general solicitation in offerings under Rule 506 of Regulation D.

In my view, I don’t think there should be an elimination of the ban on general advertising and general solicitation. That would just expose large segments of the population to potential securities fraud. Currently, ads for investment opportunities are red flags for state and federal regulators.

However, I do think it needs to a little easier for entrepreneurs to raise capital. The SEC should offer some better guidance on the limitation. They could also offer some programs and safe harbors. I assume the SEC is waiting for someone to approach them with examples. They continue to be too underfunded and too understaffed to be proactive.

Will the Access to Capital for Job Creators Act be enacted? I doubt that it would pass in its current form. It takes away some investor protection and warning system for securities regulators. That would seem a bad position when the country is stealing trying to recover from the massive losses of 2008.

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Is the SEC Going to Reform Advertising Rules?

Advertising and corporate communications is a rough area for compliance when used in capital formation. The rules are restrictive, not always intuitive, often vague, and in direct opposition to the revenue-hungry side of the company.

Last week, the House Committee on Oversight and Government Reform heard testimony on “how securities regulations have harmed public and private capital formation in the United States.”

“Economists now estimate that the market for underwritten initial public offerings in the U.S. have plummeted from an annual average of 530 during the 1990s to about 126 since 2001. Meanwhile, the number of companies listed on the major American exchanges peaked in 1997 at more than 7,000. Today, there are approximately 4,000. Furthermore, private capital formation in the U.S. is increasingly difficult, as demonstrated by Facebook’s recent decision to issue its high-profile private offering to foreign investors but not Americans.”

Since I’m in the private equity sector, I care more about the limitations placed on private capital formation. SEC Chairman re-stated the justification for the ban on general advertising under Regulation D.

“The ban was designed to ensure that those who would benefit from the safeguards of registration are not solicited in connection with a private offering.”

“I recognize that some continue to identify the general solicitation ban as a significant impediment to capital raising for small businesses. I also understand that some believe that the ban may be unnecessary because those who do not purchase the offered security would not be harmed by the solicitation that occurs. At the same time, the general solicitation ban is supported by others on the grounds that it helps prevent securities fraud by making it more difficult for fraudsters to attract investors or unscrupulous issuers to condition the market. We need to balance these considerations as we move forward in analyzing this issue.”

Barry Silbert, CEO of Second Market phrased it nicely:

It should not matter that non-accredited individuals know that unregistered securities are available for sale. No one prohibits car manufacturers from advertising, even though children under the legal driving age are viewing the advertisements. The general solicitations prohibition unnecessarily limits the pool of potential investors, thereby restricting companies’ ability to raise capital to fuel growth.

Chairman Shapiro said the SEC staff is looking at the offering rules and whether the general solicitation ban should be revisited. Given all of the rule-making from Dodd-Frank, it’s hard to imagine that the SEC will find the bandwidth to revisit the rule in the near future.

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Image is Reaching for Blue Skies by Kelvin Tan
CC BY 2.0

Whether the Advertising or Solicitation Was General in Nature Under Rule 502(c)

Barnum and Bailey Limited Stock Certificate Earlier, I posted on Fund Raising Publicity. I ended by pointing out that Rule 502(c) prohibits general solicitation or general advertisement that occurs in connection with a Regulation D securities offering. This is to separate typical company advertising if a company advertises with no intention to “offer or sell the securities of the issuer” then such advertising should not violate rule 502(c). Yesterday, I focused on the first part of the analysis is Did Advertising or Solicitation to Offer or Sell Securities Occur?

This post focuses on whether the advertising or solicitation was general in nature.

The S.E.C. has interpreted Rule 502(c) to allow for non-general advertising, meaning advertising in which the issuer and offeree have a “pre-existing, substantive relationship.”

In 1982 the SEC gave no-action relief to a partnership that proposed to mail a written offer to three hundred and thirty people who had previously invested in another limited partnerships from the same sponsor. (Woodtrails -Seattle, No Action Letter, 1982 WL 29366, (Aug. 9, 1982)) The Commission found that these investors had a pre-established relationship with the general partner, who was described to have had a reasonable belief that the offerees were knowledgeable and experienced in financial matters.

In comparison, when a partnership dedicated to boarding, breeding, and training race horses sought to solicit investments by conducting a mailing to the Thoroughbred Owners and Breeders Association members, distributing brochures at a horse sale, and advertising in a horse racing trade journal The Commission did not give relief. Aspen Grove, No-Action Letter, 1982 WL 29706 (Dec. 8, 1982). So related interests alone are not enough to create a substantive relationship.

“The types of relationships with offerees that may be important in establishing a general solicitation has not taken place are those that would enable the issuer (or a person acting on its behalf) to be aware of the financial circumstances or sophistication of the person with whom the relationship exists or that otherwise are of some substance and duration.” Mineral Lands Research & Marketing Corp., S.E.C. No-Action Letter, 1985 WL 55694 (Dec. 4 1985).

The other alternative is the use of a broker-dealer. A broker-dealer may establish a relationship through general advertising or general solicitation, so long as such solicitation does not promote the offer or sale of securities. The broker-dealer can then solicit information from a potential investor to see if they have sufficient financial circumstances or sophistication. “A satisfactory response by a prospective offeree to a questionnaire that provides a broker-dealer with sufficient information to evaluate the respondent’s sophistication and financial situation will establish a substantive relationship.” H.B. Shaine Co., S.E.C. No-Action Letter, 1987 WL 108648 (May 1, 1987). The questionnaire cannot be too general otherwise you won’t be able to determine if the offering would be appropriate in light of the suitability standards established by the issuer . Questionnaires to potential investors must be “generic in nature” and can “not make reference to any specific investment currently offered or contemplated for offering.” Bateman, S.E.C. No Action Letter, 1985 WL 55679 (Dec. 3, 1985).

The consequences of making a general solicitation or general advertisement can be seen an administrative action taken against Kenman Corporation. The SEC found that Kenman violated Section 5 of the Securities Act by engaging in a public offering without registration. Kenman’s offering did not qualify for exemption under Regulation D or Section 4(2) because the SEC determined that Kenman had engaged in general solicitation. They had mailed materials to  a large number of people taken from a list of executive officers of Fortune 500 companies, a list of physicians, a list of company presidents in a certian area and other general lists. Kenman Corp. Administrative Proceeding File No. 3-6505 (Apr. 19, 1985)


The image is Barnum and Bailey Limited Stock Certificate in the public domain and available on Wikimedia Commons.

Advertising or Solicitation to Offer or Sell Securities Under Rule 502(c)

BirminghamMotorsStock.jpeg Stock certificate for 10 shares of Birmingham Motors automobile company

Yesterday, I posted on Fund Raising Publicity. I ended by pointing out that Rule 502(c) prohibits general solicitation or general advertisement that occurs in connection with a Regulation D securities offering. This is to separate typical company advertising if a company advertises with no intention to “offer or sell the securities of the issuer” then such advertising should not violate rule 502(c).

The first part of the analysis is Did Advertising or Solicitation to Offer or Sell Securities Occur?

In one example, Printing Enters. Management Science Inc. wanted to engage in promotional activities relating to the products and services that it offered. Since these promotional activities were to occur simultaneously with a private securities offering, the SEC was confronted with the question of whether these marketing activity were intended to facilitate the offer or sale of securities. (Printing Enters. Management Science, Inc., No Action Letter (issued Apr. 25, 1983)).The SEC declined to grant no-action relief stating that it could only evaluate whether the advertisement was in direct support of an offer or sale of securities by evaluating all the specific facts surrounding this promotion.

The SEC expanded the coverage of Rule 502(c) in its Gerstenfeld No-Action letter (Gerstenfeld, No-Action Letter, 1985 WL 55681 (Dec. 3, 1985)), explicitly prohibiting advertisements that occurred even when a private placement was not simultaneously occurring. In Gerstenfeld, a syndicator wished to place an advertisement generally stating that it sells securities, and inviting parties to contact the syndicator for further information. The SEC declined to recommend no-action.The staff concluded that the advertisement constituted a “general” advertisement and was designed to sell securities of entities that are, or will be, affiliated with the syndicator. It did not matter whether the syndicator was then in the process of selling partnership interests since the primary purpose of the advertisement is to sell securities and to condition the market for future sales.

In Alma Securities Corp. (August 2, 1982) the Staff took the position that tombstone advertisements published following the completion of a private placement could violate Rule 502(c) if they help solicit investors to invest in contemporaneous or future offerings. As stated by the staff, “where a sponsor or issuer conducts an ongoing program of private or limited offerings, tombstone announcements for the completion of each individual offering could be used to solicit investors to the program as a whole.”

The advertisement need not be one from the issuer. Third party advertisement can also cause problems. The SEC has declined to provide no-action relief regarding whether an advertisement would violate Rule 502(c) if the issuer did not sponsor the advertisement and it was published in an independent source (Oil and Gas Investor, No-Action Letter (Jan. 23, 1984)). The SEC declined to provide no-action relief to a question regarding whether an independent source could distribute reviews and analyses of various private offerings to a limited group of paid subscribers. (Tax Inv. Information Corp., No Action Letter, 1983 WL 29834 (Feb. 7, 1983)). The SEC seems to review these on a case by case basis.

Image is a Stock certificate for 10 shares of Birmingham Motors in the public domain, available on Wikimedia Commons.

Fund Raising Publicity

1903 stock certificate of the Baltimore and Ohio Railroad

Under the U.S. securities laws, it is important for private investment funds to avoid engaging in a “general solicitation” or “general advertising” prior to and during fund raising. The key to private investment funds and the private offering of interests in the funds is that they are “private.”

Assuring the private nature of an offering means that not only the issuer, but any party acting on its behalf, must refrain from generally soliciting potential purchaser. This means that a fund and its agents (which includes all management, personnel, placement agents,attorneys, accountants and other representatives) must be careful during the fund raising period not to make statements to the general public with regard to an investment in a fund.

Rule 502(c) of Regulation D states the limitation as “neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following:

1. Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and

2. Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising. . . “

If a fund or its agents make statements that could be viewed as a “general advertising” or “general solicitation”, the SEC could impose a “cooling-off period.” This would typically mean a cessation of all fundraising and a moratorium on fund closings for a period of several months. A “general solicitation” could also trigger registration of the fund sponsor or the fund under the Advisers Act or the Investment Company Act.

The SEC has indicated that it believes that the following actions violate Rule 502(c):

1. Mass mailings

2. Speaking to the media about a solicitation when funding or investment matters are discussed, whether such speech is directed at current fundraising efforts or deemed to be an attempt to “condition the market” by making reference to the success or attractive return of previous investments.

3. Print, radio and television advertisements or solicitations regarding funding or investment matters

4. Tombstone advertising (an ad which does no more than give the barest of information) is held by SEC staff to “condition the market” for the securities and therefore constituted an offer even though the tombstone did not specifically mention the transaction in question.

Rule 502(c) prohibits general solicitation or general advertisement that occurs in connection with a Regulation D securities offering. This is to separate typical company advertising if a company advertises with no intention to “offer or sell the securities of the issuer” then such advertising should not violate rule 502(c).

The image is a 1903 stock certificate of the Baltimore and Ohio Railroad in the public domain and available on Wikimedia Commons.