The Commission considered a Congressional mandate to amend our private placement rules, allowing issuers to offer securities by means of general solicitation and general advertising, provided only that all purchasers are accredited investors.
I cannot support the proposal, because it presents a framework that is not balanced and that fails to address the acknowledged increased vulnerability of investors. In fact, there is no consideration of any of the commenters’ proposals that would have decreased investor vulnerability.
Since at least 1962, the Commission has held that general solicitation and advertising are inconsistent with private offerings of securities. When general solicitation is used, investors need access to the disclosure and other protections that registration affords. In the absence of registration, and the resulting required disclosure, general solicitation and advertising can all too readily become a tool for deception and misinformation.
Investors are the source of capital needed to create jobs and expand business. I value true capital formation and economic growth, which requires investors to have both confidence in the capital markets and access to the information needed to make good investment decisions.
The Commission proposes amendments that would allow the widespread marketing of securities that, by their terms, are only intended for accredited investors. The proposal would permit solicitation and advertisements via billboards, TV, the Internet, radio, and telemarketer calls, among other avenues. Allowing such broad marketing activities under an exemption designed for “private” offerings is a significant change in the securities framework, and it would greatly increase the vulnerability of investors. Given that vulnerability, the Commission should use its expertise to effect the statutory mandate in a way that balances Congressional intent and the Commission’s core mission to protect investors.
Unfortunately, the proposal fails to consider any of the suggestions recommended by investors, investor advocates, and regulators to mitigate risk. For example, the Commission should have proposed at this time, among other recommendations:
- Amending the definition of accredited investor to require consideration of the investor’s financial sophistication; and
- Amending Form D notice requirements to enhance the timing and content of the form.
Allowing General Solicitation Exacerbates Investor Vulnerability to Fraudsters
First, let me address why investors will be more vulnerable. When general solicitation is combined with an offering exemption such as Rule 506, no information statement or disclosure is required to be given to investors. Thus, fraud can be easier to effect and much harder to detect.
In this context, it is easy to see that an issuer could use general solicitation and advertising to disseminate false or misleading information. When reliable information is scarce, fraudsters can easily spread false information. Eliminating the ban on general solicitation and advertising may also facilitate boiler-room cold calling and other high-pressure sales techniques. History shows that, when stock promoters are allowed to advertise and solicit the public without any sort of registration or qualification whatsoever, it opens the door to fraudsters and scam artists of every description.
Moreover, how will these fraudsters be caught? The short answer is that many of them will not. The Commission will not be able to discern these frauds as we can now. Currently, general solicitation accompanying a private placement is a clear red flag and jumpstarts an investigation. Going forward, this red flag would be removed, putting investors even more at risk. The proposal fails even to make an attempt to address this yawning gap by improving the content, timing, and compliance of, and with, the Form D Notice Filing.
We have heard repeatedly in a number of contexts that the anti-fraud provisions of federal and state securities laws should be sufficient to protect investors. This is a short-sighted view that has been disproven over and over again. Ask investors what it is like to be defrauded. In most cases, much of investors’ monies are long gone by the time a fraud is identified and an action can be brought. It is the Commission’s job to prevent investors from being harmed. True investor protection requires mechanisms to deter and prevent fraud before it begins.
Ways to Combat Fraud
Making Sure Investors in Private Placements Can Truly Fend for Themselves
I am now going to walk through several ideas to decrease the vulnerability of investors that could easily have been a part of the Commission’s proposal. In fact, it is surprising that these ideas are receiving no airing, given the clear increase in investor vulnerability. One way to combat fraud is to make sure that purchasers truly have the capacity to fend for themselves. Congress identified this issue when it limited general solicitation and advertising under Rule 506 to offerings in which ALL the purchasers are accredited investors. Underscoring the importance of this requirement, the statute calls for the SEC to write rules requiring issuers to verify that purchasers of securities are accredited investors.
Representative Maxine Waters, who introduced the verification requirement in the U.S. House of Representatives, explained the purpose as follows:
If we are rolling back protections for our targeted audience of sophisticated individuals, we must take steps to ensure that those folks are in fact sophisticated.
However, the effectiveness of this requirement assumes that the purchaser actually has sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the prospective investment. Currently, a natural person may qualify as an accredited investor solely on the basis of income or net worth, without regard to any investment experience or financial sophistication. Accordingly, as we consider rules that would allow unregistered securities to be marketed to accredited investors through cold calling, Internet promotions, and other forms of solicitation, we must also consider the accredited investor definition at the same time. For example, some commenters have previously suggested that demonstrating actual investment experience would indicate a level of financial sophistication, which could supplement the existing definition.
Form D Filing
A second way to deter fraud is to require the issuer to make a notice filing on Form D a reasonable period of time prior to making any offers or sales using general solicitation or advertising. Currently, the rules require an issuer to file a Form D within 15 days after the first sale in a Regulation D offering, but that requirement is not a condition to the exemption and for practical purposes is essentially voluntary. A true requirement that notice on Form D be made before general solicitation begins would serve three purposes. First, it would prevent any issuer that fails to file a notice from claiming that improper advertising or solicitation activities were intended as part of a legitimate Rule 506 transaction. This could reduce the amount of such activity by issuers seeking to condition the market or otherwise abuse the exemption. Second, it would provide a mechanism for potential investors to identify the source of an offer, facilitating some degree of due diligence. Third, it would provide a mechanism for regulators to be made aware of a “mass marketed” offering before it is launched.
Moreover, the potential value of a filing on Form D could be significantly enhanced, at little expense to the issuer, by modestly expanding the information required to be provided on the form. For example, such basic information as the issuer’s Internet website address, the names of any controlling persons, the size of the issuer, and — in the case of any offering of interests in a pooled investment vehicle — the name, address, and controlling person of any investment adviser is critical for potential investors and regulators to confirm the bona fides of the offeror. In fact, one must wonder why particular issuers would not be willing to disclose such basic information if that were the case.
Additional Potential Reforms
Other commenters have proposed additional ways to address the increased fraud risk posed by general solicitation and advertising in unregistered offerings. For example, the Commission could require that any advertising under our amended rule comply with guidance similar to that applicable to advertising for registered offerings, including a “balanced presentation of risks and rewards” and a requirement that statements in advertising are consistent with representations in any offering documents. Other potential reforms could include:
- Mandatory “cooling-off” periods, within which investors could terminate a purchase without risk;
- “Warning labels” highlighting the risks of investing in unregistered securities; and/or
- Tightened integration rules, so that general solicitation or advertising for one offering could not be used to condition the market — or pump up the stock price — for another offering.
Clearly, the proposal fails to address the increased vulnerability of investors. I believe that we cannot fulfill our mandate without robustly addressing the risks posed by unregistered general solicitation with concrete proposals.
The Commission did not even attempt to issue a proposal that addresses the increased vulnerability of investors. To that end, I have set forth in Appendix A a list of questions to highlight these issues that I ask commenters to address.
Request for Comments
The Commission has received numerous public comment letters urging the Commission to propose other amendments to Regulation D or to Form D that commenters believe are appropriate in connection with the elimination of the ban on general solicitation and advertising. The comment letters referred to below can generally be found on the Commission’s website at http://www.sec.gov/comments/jobs-title-ii/jobs-title-ii.shtml.
It is important to note that Rule 506 is currently the broadest of the safe harbors under Regulation D. It permits offers and sales to be made, without registration, to an unlimited number of accredited investors. In addition, there is no limit on the amount of money that can be raised in an offering pursuant to Rule 506. If sales are made only to accredited investors, there are no information or disclosure requirements. Securities offered pursuant Rule 506 are also exempt from state “blue sky” laws.
Given the breadth of this exemption, it is hard to understand how the Commission’s proposal to allow general solicitation with private placements ignores the increased vulnerability of investors in its entirety. I urge interested persons, and in particular investors and their advocates, to submit comments on the following topics, which the Commission’s proposal is deficient in failing to address:
A. Manner and Content of General Solicitation
Section 201(a) of the JOBS Act mandates that the Commission eliminate the prohibition against general solicitation and advertising (“general solicitation”) in offerings made under Rule 506, but does not address whether the Commission should adopt rules regarding the content of the general solicitations used in these offerings or the manner in which potential investors are solicited in these offerings. A number of commenters have expressed views on the need for the Commission to adopt specific standards or requirements that would govern the content that may be included in general solicitation materials used by issuers in offerings conducted pursuant to Rule 506, as amended.
One commenter recommended that the Commission require any advertising used in Rule 506 offerings to comply with requirements similar to those applicable to registered offerings in order to prevent deceptive or misleading advertising. Another commenter articulated similar concerns regarding fraudulent advertising, recommending that, among other things, the Commission adopt a uniform set of required disclosures and content restrictions for general solicitation materials, such as a mandatory legend disclosing those jurisdictions where the offering is being made (and disclaiming sales in any others) and a prohibition on financial projections or statements of future performance. This commenter noted that, in the absence of Commission-developed content standards, advertising in Rule 506 offerings would be subject to different requirements depending upon whether the transaction is sold by broker-dealers, who are subject to FINRA’s rules regarding public communications, or by issuers directly.
Request for Comment
- 1. Would a condition that issuers include certain mandated legends or disclosures in any written general solicitation materials used in connection with a Rule 506(c) offering enhance the protection of investors? Would the inclusion of such a legend also help regulatory bodies identify communications made in the private offering market? Would such a legend come at a minimal marginal cost to issuers preparing their general solicitation materials, particularly if they are in written form? What information should be required in the legends or disclosures?
- 2. Outside of the privately offered fund context, should the Commission consider proposing rules that would restrict or establish standards for the content of general solicitation materials or for the manner or means of general solicitation in offerings made under proposed Rule 506(c)? If so, what should they be, and why? Do different means through which investors can be solicited pose different concerns? If so, what are these means and concerns?
- 3. Does the fact that there are essentially no content requirements regarding general solicitation materials used in connection with a Rule 506(c) offering present any problems?
B. Amending the Definition of Accredited Investor
In connection with the amendment to Rule 506 to implement the mandate in Section 201(a), some commenters have recommended that the Commission also amend the definition of “accredited investor.” The Commission initially adopted the definition of accredited investor in Rule 501(a) in 1982, when it adopted Regulation D. The definition was last amended pursuant to Section 413(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) to exclude the value of a natural person’s primary residence for purposes of determining accredited investor status on the basis of net worth.
Request for Comment
- 4. What characteristics should the definition of accredited investor seek to identify? Should the Commission amend the definition of accredited investor? If yes, in what manner? If not, why not? Should there be multiple levels of accredited investor, with different qualifications, applicable in connection with various different exemptions? Should the definition of accredited investor include a threshold test of demonstrated investment experience?
C. Making the Filing of Form D a Condition and Related Issues
Some commenters have urged the Commission to require the filing of a Form D as a condition to the availability of the proposed Rule 506(c) exemption or of any of the other exemptions under Regulation D, such that the failure to file the form in accordance with the rule would result in the loss of the safe harbor and potentially of the exemption itself. While the filing of a Form D is currently a requirement of Regulation D, it is not a condition of the Rule 506 exemption.
The Commission has previously stated that the information in Form D is useful for a number of purposes, such as facilitating the enforcement efforts of the Commission, state regulators and FINRA, as well as serving as a source of information for investors and as a tool for the collection of data for use in the Commission’s rulemaking efforts. The need for the information required to be provided in Form D may be greater when the Commission eliminates the prohibition on general solicitation for certain offerings. Among other concerns, failure to file Forms D will make it more difficult for the Commission to assess market practices under Regulation D, including any practices used to satisfy the verification requirement in proposed Rule 506(c) and whether non-accredited investors are purchasing in Rule 506(c) offerings.
Request for Comment
- 5. Should the filing of a Form D be a condition to the availability of the proposed Rule 506(c) exemption or of any of the other exemptions under Regulation D? Why or why not? If so, should the Commission also consider providing that an issuer could cure the failure to file a Form D in a timely manner and thereby avoid losing the ability to rely on proposed Rule 506(c) under certain circumstances? If so, what circumstances should such a cure provision cover?
- 6. What would be the costs and benefits of conditioning the proposed Rule 506(c) exemption on the filing of the Form D? What effects would such a condition have on issuers that wish to conduct offerings pursuant to proposed Rule 506(c), particularly smaller businesses? Would such a condition enhance investor protection by providing investors and regulators with publicly available notice of an issuer’s reliance on proposed Rule 506(c) for its offering and its use of general solicitation? Would such a condition enhance investor protection by causing issuers to exercise a greater level of care when conducting Rule 506(c) offerings.
- 7. Should the Commission consider some other rule or take other regulatory action to improve compliance with the Form D filing requirement? For example, if the failure to file a Form D would result in a sanction such as a monetary penalty, would this improve compliance with Rule 503’s filing requirement?
- 8. Should the Commission consider requiring an advance filing of the Form D for issuers that intend to engage in general solicitation for their Rule 506(c) offerings, as some commenters have suggested? If so, how far in advance of the offering should the filing be made? What effect would this advance filing requirement have on issuers’ ability to raise capital through Rule 506(c) offerings? If the Commission does not consider requiring an advance filing of Form D, what mechanism will it adopt to track private offerings?
- 9. Should the Commission consider proposing an amendment to Form D to require additional information, as some commenters have suggested? For example, should the Commission require issuers to provide information on Form D about the types of purchasers by category of investor and by size, as some commenters have suggested? Should the Commission require issuers to provide information on Form D about the types of general solicitation used (e.g., oral communications, written communications such as mass mailings and emails, websites, or television); and the methods used to verify accredited investor status (e.g., public data, data provided by an intermediary, or data provided by a purchaser)? Would these types of information provide the Commission with a better view of the Rule 506(c) market and of the practices that develop to satisfy the verification requirement, or help the Commission assess the effectiveness of various verification practices in identifying and excluding non-accredited investors from participation in proposed Rule 506(c) offerings? Is there other information that should be required to be included in a Form D filed for offerings made under proposed Rule 506(c)?
- 10. Form D originally included a requirement for a closing filing, which was eliminated in 1986. At the time, the Commission anticipated that eliminating the requirement would have negligible consequences for investors and would result in some cost savings for both issuers and the Commission. Because the Commission has a far better ability to analyze the Regulation D offering market through information supplied on electronically-filed Forms D, collecting such information upon the completion of the offering may provide greater benefits than it did in 1986. Should the Commission consider proposing to require issuers to file an amendment to Form D upon completion of the offering, to update the total amount sold and the other information in the Form D? What would be the cost to an issuer in terms of filing another notice?
- 11. Should the Commission propose an amendment to Form D to require that an issuer that is relying on an exclusion from registration under the Investment Company Act identify the fund’s investment adviser and whether the adviser is registered with the Commission or exempt from registration?
- 12. Should the Commission propose to require the filing of general solicitation materials, as some commenters have recommended? Should that filing be made public or be filed confidentially with the SEC?
D. Specific Issues for Privately Offered Funds
The Commission received a range of comments recommending different approaches to eliminating the prohibition on general solicitation with respect to privately offered funds. One commenter expressed concern that eliminating the prohibition against general solicitation could result in greater fraudulent activity in the offer and sale of privately offered funds, as it would be easier for promoters of fraudulent schemes to reach potential investors through advertising and other methods previously not allowed and to communicate false and inaccurate information. This commenter recommended that the Commission consider, among other things, imposing content restrictions (such as on performance advertising) on privately offered fund advertising similar to those that apply to registered investment companies to prevent misleading advertising. Others disagreed with this view. They asserted that purchasers of the securities of a privately offered fund that relies on Rule 506, as amended, must be, at a minimum, accredited investors and thus have met objective criteria demonstrating financial sophistication, which eliminates the risk that other types of investors could be defrauded.
Request for Comment
- 13. Is further rulemaking or guidance on privately offered fund advertising necessary or appropriate? For example, should the Commission consider enhancing privately offered fund advertising regulation (e.g., imposing some or all of the content, performance standards, and oversight regime that applies to registered investment company advertising)? Or, is current regulation under the Investment Advisers Act of 1940 (the “Investment Advisers Act”) applicable to privately offered fund advertising sufficient? Should the Commission provide privately offered fund managers with more guidance and certainty with respect to the advertising limits under the Investment Advisers Act, and the rules thereunder, to permit these managers to disclose more information to their investors?
E. Additional Issues
Request for Comment
- 14. As a condition to the availability of the proposed Rule 506(c) safe harbor, should the Commission consider imposing specific recordkeeping requirements regarding the steps that an issuer has taken to verify that a purchaser is an accredited investor? If so, how long should the records be kept? Would such requirements deter investors from participating in proposed Rule 506(c) offerings (for example, due to privacy concerns)? Would such requirements enhance investor protection?
- 15. Currently, a non-affiliated investor who purchases securities through a private offering exempt under Section 4(a)(2) and Regulation D (other than in certain cases under Rule 504(b)(1)) will receive restricted securities. Once the holding period requirement of Securities Act Rule 144 (which is six months for an Exchange Act reporting issuer and one year for a non-reporting issuer) is met, the investor can generally resell the securities to anyone in reliance on Rule 144. Is there a risk that the elimination of the prohibition against general solicitation will lead to conditioning of the secondary trading market for the securities once they can be resold under Rule 144? What is the best approach towards preventing such conditioning? Should the Commission be concerned about issuers promoting through general solicitation the resale of securities by existing holders?
- 16. Section 201(c) of the JOBS Act amended Section 4 of the Securities Act to provide an exemption from the requirement to register as a broker-dealer under Section 15(a)(1) of the Exchange Act for persons who engage in certain limited activities with respect to securities offered and sold in compliance with Rule 506 of Regulation D, subject to certain conditions. Is there a need for the Commission to provide guidance on any aspect of this exemption? For example, should the Commission provide clarity on the terms “platform” and “mechanism”? Is the prohibition on receiving compensation clear, or should the Commission provide additional guidance in this area? Is there a role for these platforms in helping an issuer determine whether a person is an accredited investor? If so, what would be the consequences, particularly with respect to investor protection and capital formation? What would be the likely effects of Section 201(c) on the role that broker-dealers currently play in Rule 506 offerings? Will their role diminish?
- 17. What would be the collective effect on the capital markets of the ability to offer securities through general solicitation under proposed Rule 506(c), the current holding period requirements for restricted securities under Rule 144, and the availability of broker-dealer operated trading platforms (e.g., alternative trading systems) that facilitate resales of securities of non-reporting issuers, particularly with respect to the need or desire of issuers to conduct registered offerings? Would the incentives for issuers to register securities offerings be undermined? Would investors be harmed by this possible trend and if so, how? How would the elimination of the prohibition against general solicitation in proposed Rule 506(c) offerings affect the use of broker-dealer operated trading platforms for resales of non-reporting companies’ securities? Should the Commission take any particular steps to address expected consequences?
- 18. The ability of issuers to offer securities through general solicitation under proposed Rule 506(c) raises questions under the integration doctrine. Some have suggested, for example, that all private offerings made subsequent to the commencement of general solicitation activities be integrated. One commenter noted more generally that the Commission should, at some point, clarify issues regarding the integration of Rule 506 and Rule 144A offerings that use general solicitation with other public or private offerings conducted by the same issuer (and that the Commission should be mindful of the Congressional intent to facilitate capital formation while maintaining investor protection). How should the integration doctrine apply to offerings made under proposed Rule 506(c) and registered offerings or offerings made under other exemptions (including Rule 506(b))? Should the Commission amend Securities Act Rule 152, Securities Act Rule 155, or Rule 502(a) of Regulation D (all of which relate to the issue of whether certain offerings need to be integrated)? Are there any issues arising from the ability of issuers to offer securities through general solicitation under proposed Rule 506(c) and the ability of emerging growth companies to use “test the waters” communications regarding a registered offering under Section 5(d) of the Securities Act? If so, what actions should the Commission take to address these issues? Should the Commission provide guidance on how the proposed amendments to Rule 506 and Rule 144A affect the application of the integration doctrine?
- 19. Are there any other rule amendments necessary or appropriate to implement the statutory mandate of Section 201(a) of the JOBS Act? Are there any other measures that the Commission should consider taking in connection with the removal of the prohibition against general solicitation?
- 20. Does the economic analysis section in the proposing release fairly describe the reasonably expected costs and benefits associated with the proposed rule, including both those attributable to Congressional mandates and those that result from an exercise of the Commission’s discretion?
- 21. Please provide any available information with respect to the reasonably expected costs and benefits associated with any provisions recommended for the Commission’s consideration in connection with this rulemaking.