In another blog, I mentioned there are two unusual and potentially highly important (yet surprisingly brief) securities law bills now pending before the US Congress. In that blog, I wrote about the “Entrepreneur Access to Capital Act” (H.R. 2930) that would create an entirely new exemption -- a 21st Century social media category exemption -- to the registration requirements under federal securities law.
In this blog entry, I will describe the other bill and explain why I consider it -- although even shorter than HR 2930 -- to have potential to bring about large changes in the capital raising world for small businesses.
Some Background
When small businesses seek to raise capital through transactions exempt from registration under the Securities Act of 1933, as amended (see my other blog for a quick explanation of why a business has to either register an offering under the Act or comply with the conditions of an express exemption from registration; otherwise, the business is likely violating federal and state securities laws and exposing itself and its controlling persons to serious consequences), the usual, although not exclusive, route is a private placement of securities. Most businesses and almost all attorneys are familiar with the concept of “private placements” and many are knowledgeable about the “private placement memorandum” or “offering circular” often prepared (although not always necessary) in connection with that kind of transaction.
A “private placement” exemption is found in two places under the Act: Section 4(2) and rules adopted by the SEC under authority granted it in Section 3(b).
Under the latter, the SEC adopted Rules 504 and 505 of Regulation D. Rule 505 has little remaining vitality today, and although Rule 504 is still “active” it lacks the “oomph” that many businesses want, because the aggregate offering amount for any 12 month period is capped at $1 million.
On the other hand, Section 4(2) private placements have occurred since the 1930s, when the statute was enacted.
Section 4(2) says only that “The provisions of Section 5 [that is, the section of the Act which makes it illegal to offer or sell securities unless the issuer has properly registered them for sale under a registration statement with the SEC] shall not apply to transactions by an issuer not involving any public offering.”
For nearly 50 years, it was left to courts to interpret what a transaction “not involving any public offering” meant. Over those decades, courts did develop, on a case by case basis, the elements of a “private offering.” But because there were no precise standards applicable on a national basis, any issuer using Section 4(2) to private issue securities was wading into a somewhat murky situation.
About 30 years ago, the SEC adopted Rule 506 of Regulation D to create a “safe harbor” for private placements: a set of fairly specific guidelines (which largely codified the case law) that, if met, would be deemed to satisfy Section 4(2). With Regulation D’s adoption, practitioners have taken to distinguishing “Reg D” offerings from “statutory private placements,” with the latter reduced to private placements that do not satisfy Regulation D conditions (usually at the issuer’s choice) but still come within (or at least the issuer hopes come within) Section 4(2).
Regulation D revolutionized the private placement exemption and (in the context of a booming US economy in the 1980s) practically created the modern private placement phenomenon.
One condition carried over from the case law and enshrined in Regulation D offerings was the requirement that a transaction “not involving any public offering” not involve general solicitation of or general advertising to potential or actual offerees or buyers. What constitutes general solicitation or general advertising is spelled out in Rule 502(c) and includes, but is not limited to, media or broadcast advertisements or communications or seminars or meetings promoted by such means. The SEC in practice goes further, and expects that offers and subsequent sales will be made only to persons with whom the issuer (or a broker or placement agent acting on its behalf) has a “preexisting relationship.”
The SEC loosened this prohibition on general solicitation for Rule 504 offerings several years ago, permitting issuers to engage in general solicitation or general advertising for offerings made exclusively under state securities law exemptions which permit such solicitation and advertising if the buyers (as contrasted with offerees) of securities are all “accredited investors” under Regulation D. In other words, assuming the other conditions are satisfied, an issuer could use newspaper, radio, television or internet or email advertisements to invite the public to look at its stock offering or to attend a seminar where the offering is promoted, but the issuer could not sell securities to anyone who did not qualify as an “accredited investor.” Or in other words, you can cast your lure in a bigger lake with more fish, but you have to release all of your catch except the big ones.
The Access to Capital for Job Creators Act (HR 2940) will destroy the general solicitation condition for statutory private placements and basically conform Rule 506 with Rule 504 on this issue.
What the Bill Says
The “Access to Capital for Job Creators Act” would amend Section 4(2) of the Act to remove general solicitation or general advertising as an element of the exemption. The Act would also instruct the SEC to modify Rule 506, within 90 days of the Act’s enactment, to conform with Rule 504‘s looser requirements by eliminating the prohibition against general solicitation or advertising as to offerings or sales under Rule 506 so long as sales (but not offers) are made only to accredited investors.
Part 2 will discuss what the bill may mean to a typical small to medium size business, and where the bill stands now.