SEC Lifts Ban on General Solicitation of Private Offerings
Shriram Bhashyam | July 11, 2013
The SEC voted yesterday to lift the 80-year old ban on general solicitation of private offerings of securities pursuant to SEC Rule 506, which is commonly relied upon by private funds, startups, and crowdfunding platforms. While you won't likely see a deluge of hedge fund and VC fund ads airing on TV during Breaking Bad or the Real Housewives of Blah Blah Blah, the largest funds (think Bridgewater or Blackstone) may start advertising strategically (e.g., the first class lounge at JFK), and social media advertising may see an overall uptick. Startups will also be able to take greater control of their own fundraising efforts, and the crowdfunding world will also benefit from the SEC's action (although those folks are still awaiting SEC action on the crowdfunding provision of the JOBS Act).
Advertising is Unlimited, But Participation is Still Limited
Yesterday's vote by the SEC fulfilled the Congressional mandate in the JOBS Act (enacted in April 2012) to remove the prohibition against general solicitation of Rule 506 private placements. While there is no restriction on who an issuer can solicit, sales will still be limited to accredited investors, which generally includes certain institutions and individuals who earn more than $200,000 per year or whose net worth exceeds $1 million (exclusive of their primary residence). In this regard, issuers will be required to take "reasonable steps" to verify that purchasers of the securities being offered are accredited investors. Amended Rule 506 provides non-exclusive safe harbors for such verification, including:
- obtaining (i) tax forms evidencing the purchaser's income and (ii) a written representation that the purchaser expects to earn the necessary income in the current year; or
- obtaining a written confirmation from a broker, investment adviser, attorney, or CPA that the issuer has taken reasonable steps to verify that the purchaser is an accredited investor.
Regulation Catches Up with the Times
By removing the ban on general solicitation, the SEC has taken a crucial step in fostering capital raising and making regulation harmonious with the times. Congress's purpose in enacting the JOBS Act was to make capital raising easier, and the amendments to Rule 506 help accomplish this by making it easier to find eligible investors. Let's also bear in mind that the prohibition was put in place when the principal avenues for advertising were print and radio. We live in the digital age where information is king, and the threat of violating SEC general solicitation rules by providing basic information or saying the wrong thing at a conference hamstrung companies and fund managers. Putting the amendments to Rule 506 in the context of the SEC's recent embrace of social media
, we see that the securities laws are trending in the right direction--toward modernization.
Don't expect to see an ad for the Paulson Advanced Quantitative Strategies fund in your local newspaper. These are not the investors that private funds are targeting. It is more likely that a well-known fund will sponsor some posh gala in the Hamptons. Smaller funds may use low-cost avenues such as social media. Additionally, as AdTech firms are continually pushing the limits of targeted advertising, funds may use digital advertising to target accredited investors.
Impact for Startups and Crowdfunding Portals
As the path to IPO for startups has become longer (by some measures
, over 9 years now versus 5.5 years for startups between 1997 and 2001) and regulatory and public scrutiny has increased (see the recent spate of poor IPO performance by tech companies), raising capital through private markets has increased in importance. With the lift of the ban on general solicitation, startups can now publicly announce that they are raising funds, rather than having to pursue capital in a hushed manner.
This will only be compounded by the growth of crowdfunding. The crowdfunding space is no doubt overjoyed by the SEC's vote. While the crowdfunding provision of the JOBS Act, which would allow companies to seek small equity investments from all investors (not just accredited investors) has yet to be implemented, crowdfunding portals can nonetheless more easily promote their offerings and match companies with accredited investors who are excited about a certain business. By being able to cast a wider net in promoting their portals, crowdfunding websites will be able to find more accredited investors to participate on their platforms.
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The amended rules become effective as of September 23, 2013.
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