Why is the ACA making a big deal about the SEC proposed ruling?

I am being asked, why is the SEC proposed ruling such a big issue?

Unless you read the entire ruling and get to talk either directly or indirectly to SEC staff, it doesn’t seem like a big issue. 

Simply put, the proposed SEC ruling is (a) trying to fix a problem that doesn’t exist; (b) will increase risk in our early-stage deals by adding a dimension of regulatory risk that isn’t there now; (c) will increase the cost and time for getting deals done; and (d) violates the Congressional intent of the JOBS Act, which recognized that using angel investment to create more jobs in startup companies was good for the US.

Their proposed ruling is setting new policy by bureaucrats in an area where the policy should be set by legislators

There are several issues here:

  1. What constitutes a general solicitation?  One reason I welcomed the JOBS Act provision on general solicitation was that Angel groups hit that boundary many times.  My angel group, the AoA, was ultra-conservative. For example, we didn’t give our 2 page startup summary sheets to guests, who had not yet given us the accredited investor forms.  Other groups, like Zino Society, did big events (Zillionaire Forum) that are attended by many people who aren’t accredited.  While I think this is a great idea, since it exposes new people to startups and helps fund them, are the companies that present there using general solicitation?  When a company posts its plan to Gust (as the AoA requires), are we generally soliciting?  We live in a connected world, with social media being the norm, so the new rules should take that into account. But, the boundaries are murky and, if the proposed rules are adopted, the consequences of a mistake are draconian.
  2. When the JOBS Act passed (and remember I was an insider), Congressional intent was to help angels fund more companies.  The new SEC rules not only won’t achieve that intent, but will make it harder, because of the uncertainty.  I will likely avoid investing in any deal that uses general solicitation. If the startup company makes a mistake, I will lose my investment quickly, since they will have spent my money (as I want them to) and not be able to return it when the deal is rescinded. Even if the deal is not rescinded, they will be prohibited from raising money under Reg D for one year; that is a death sentence for a startup.
  3. The old rules provided a safe harbor to the companies (the investors were accredited if they said they were).  The new rules do not provide safe harbor.  The companies must verify that each investor is accredited and not a “bad actor.”  That responsibility is on the company and their board.  To get that degree of certainty, our advisors are saying that each issuer must do a background check with a third party, which will cost several thousand dollars per investor.
  4. I most certainly won’t give personal financial records of any type to a startup. Perhaps a third party verification industry of broker/dealers will emerge that will do so, but that will add cost and complexity. Furthermore, that will likely mean I will have to fill out additional myriad forms for each investment, attaching my tax returns, bank accounts, etc. each time. Again, I find myself asking “what problem are you trying to solve?” Public market equities don’t require me to jump through any hoops. Seems simpler.
  5. If you think you are not using general solicitation, but later it is determined that you did (e.g. presented at a public event, did a post on a social network, talked to a reporter, or potentially even told a customer who asked how you could ship your product), the impact is draconian.  You have 30 days to file an amended form D, allow your existing investors to rescind, and potentially face a one-year ban on fundraising. 
  6. Today, if you use Reg D, 506b (quiet), you can file after you raise the money (15 days).  If you do use 506c, then you must file an Advance Form D 15 days BEFORE the first time you generally solicit.  So, that would mean that you will need to file before you speak to your first investor and then file (an amended Form D) when you reach final terms.  And the Form D is posted to a web site that can be reviewed by the State Security Administrators.  We believe that this is the reason for this whole process – they want to do away with Federal preemption of Reg D filings.  They can then require a company to jump through myriad state hoops, as they have done in Alabama.
  7. The SEC is making the Reg D forms much more complex.  You can read that to mean that legal fees will be substantially higher.  This will make smaller deals (which we have been advocating) more problematic.

For a more thorough treatment of these issues, see: http://www.startuplawblog.com/

Hope this helps.

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