In our article, Redrawing the Public-Private Boundaries in Entrepreneurial Capital Raising, we examine what the JOBS Act (enacted earlier this year) tells us about the division between the public and private spheres in securities regulation. On its face the JOBS Act broadly expands the private realm as defined by our national securities laws. It provides two new exemptions from registration (crowdfunding and Regulation A+) and will broadly expand the reach of the most-used existing exemption from registration by removing the ban on general solicitation from exempt offerings made pursuant to Rule 506, provided they are made only to accredited investor. Yet legislative reform has done little to shore up the shaky foundation of existing theory that guides how we have thought about dividing public from private obligations in this area of the law. For the Securities Act of 1933 Act, the part of securities regulation that regulates the capital-raising, the changes spotlight a lingering identity crisis: Given the ever-expanding presence of Securities Exchange Act of 1934 Act regulation over the last half-century (e.g. integrated disclosure, shelf registration), is there any place left for the additional regulation traditionally provided by the ’33 Act?
To better understand these issues we look at the evolution of two somewhat out of the way securities transactions — reverse mergers and PIPEs — located in the transition space as companies move between the episodic disclosure requirements of a registered public offering under the ’33 Act and the recurring disclosure and obligations imposed by the ’34 Act. What we see are innovative hybrid forms of capital-raising (a ’33 Act function), although clothed in a transactional setting that takes advantage of the less intense regulation of the ’34 Act. We analyze these transactions against the core functions long performed by securities regulation: mandatory disclosure, SEC review, restrictions on sales pressure, and liability aimed to force due diligence. When one or more of these is compromised or abandoned we ask why and if we are comfortable with what compensates for the loss? More specifically, we identify the particular concern that motivates additional regulation imposed by the ’33 Act for issuer or affiliate sales: will there be a “dump” of a large quantity of stock that will require special selling efforts, with the potential for abuse that entails? We note that these fundamental questions do not always get asked when creative lawyers and their clients claim open spaces created by technological change and aggressive marketplace innovation. These private actor first movers assert favorable regulatory treatment for new forms of transactions, of which the SEC only becomes fully aware after the practice has already been established and when it is very hard to undo the occupation.
This same structure animates our analysis of the changes made by the JOBS Act to the exemptions available under the ’33 Act. For the two new exemptions added (crowdfunding and Reg. A+) we see a balance between legislative requirements that will promote due diligence in order to protect investors and the scaled back requirements for disclosure, review and liability that will reduce costs for smaller issuances, while still providing investor protection. Given the small amount of sums to be raised, and the alternative exemption paths available, these particular exemptions may end up getting very little use, at least by serious issuers. However, for the third major change of the Act, the removal of the general solicitation ban for offerings under Rule 506, which surely will be widely used, the legislation flew in the face of the fundamentals — permitting what is likely to be intense selling efforts on the Internet and elsewhere with no due diligence or liability constraints.
Having identified special sales effort as what justifies ’33 Act regulation, we ask whether this concern might better be addressed with a more technology-driven, forward-looking rethinking of how we regulate sales practices in the securities industry even if that regulation would be outside of the ’33 Act context to which we are accustomed. Our conclusion here is positive, with a condition so unlikely as to perhaps destroy its value — that sufficient regulatory resources exist for such a repositioning.
The full text of the article is available here.