Crowdfunding for Equity Solution: 6th in a Series by David Drake

July 2, 2012 - PRLog -- Perhaps it was no surprise when Mary Schapiro, Chair of the Securities and Exchange Commission, told a House subcommittee on June 28, 2012 that the Securities and Exchange Commission will not meet the July 4, 2012 deadline impose under the JOBS Act to implement rules for lifting the general solicitation ban under Regulation 506, Section D.

The difficulty, according to Ms. Schapiro, is the JOBS Acts requirement that the SEC implements rules to assure that issuers, who make a general solicitation, such as through advertisements, verify that they are accepting investments only from accredited investors. “We want to create something that is workable and usable,” she said. The SEC Chair expects that general solicitation rules will be issued “this summer.”

Verifying investors

The promise that we can expect rules this summer is encouraging and badly needed. Representative Patrick McHenry probably summed up the urgency for the rules by advising Ms. Schairo: “Entrepreneurs are waiting and we urge you to move forward with that.”

As the SEC develops rules for general solicitations, issurers must understand that they will need to to move cautiously if the plan to use general advertisement to solicit offerings. The JOBS Acts require that issurers verify that they are accepting investments only from accredited investors under the SEC Act. The SEC rules ultimately will determine what verification process is needed and whether any safe harbors are available. We suggest that issurers looking forward to make general solicitations stay apprised of developments as the SEC formulates its rules, so that issurers are prepared to move forward when the rules go public.

Background

The Securities & Exchange Act in 1933 required that only accredited investors could be solicited for investments and non-accredited investors could not be unless they had an exemption through Reg A, Reg D, a Direct Public Offering or a registered security being traded on an exchange.

Under the 1933 Act, the accredited investor was considered someone that made $200,000 per year the previous 2 years and expected to make $200,000 the following year or a couple making $300,000. The other criteria that would allow you to qualified as an accredited and sophisticated investor would be that you had a net worth of $1,000,000.

While the Dodd Frank Act was under consideration, the SEC pushed for a high net worth amount for an accredited investor. This was highly opposed and removed. What was accomplished out of the Dodd Frank Act was:

a) the equity of your primary home would not count towards your net worth.
b) Debt surpassing your equity would count against your net worth.
c) The equity in your summer / vacation / secondary home would count towards your net worth.
The Dodd Frank Act also prohibited the SEC from adjusting the net-worth threshold for a natural person for four years.

If you take inflation into consideration, the $200,000 per year salary in 1933 would be the equivalent of north of $5,500,000 today and the net worth requirement set in 1933 would represent a net worth of north of $27,000,000 today. Wow, that would not leave many people to invest. Another argument would be that are only rich people entitled to invest in private and exciting deals? Are the select few that made money on Facebook the only ones to 'give it' to the less rich?

Granted, $200,000 makes you rich today but I was alluding to the rich just like their counter parts in 1933. Remember, the SEC 1933 & 1934 Act was created to protected the non-accredited investors from fleecing but also to assure that they did not leverage their home 99% and spend all their money on stocks that would not only be worthless but put them jobless and homeless. The 1929 crash that led to the great depression was extreme.

While the status quo remains for determining the financial threshold of an accredited invesetor, a fundamental change is approaching on solicitation. Currently, any issuer intending to rely on Rule 506 of Regulation D cannot engage in any general solicitation or advertising to attract investors. The Jumpstart Our Business Startups Act (JOBS Act) directs the SEC to remove this prohibition. The critical question is whether the SEC will have new rules in place by July 4, 2012 as mandated under the JOBS Act.

History of the Non-Solicitation Rule

Here is a little history on the non-solicitation rule. Be reminded that there was no TV or internet in 1933. The ban on solicitation to non-accredited investors forced brokers and companies to only talk to 'rich' people for investments, that is, the accredited investors. The JOBS Act asked the SEC change the writing in 90 days - that is July 4th, 2012 - Independence day -- at which point advertising online, via email to millions or on TV would allow you to advertise you wanted capital for your stock to the general public.

Note, you still could only take money from accredited investors but the monumental change is that you can freely advertise wildly. Yet again, you would lose your exemption status under Reg D 506 if you took one single non- accredited investor and they decided to sue you later for loss of capital - a rare occasion but a legal premises that may hold true. So, will this amendment be implemented by July 4th and we will see media go bananas with everyone with their mother advertising stocks of private companies you can buy?

Conclusion

No, the SEC will not allow such madness as they will implement a safe harbor to assure that the 'accreditation" of an investor through this means is verifiable and not necessarily just self-monitored by the issuer.

David Drake is a founding board member of CFIRA. Crowdfund Intermediary Regulatory Advocates, or CFIRA, was established following the signing of the Jumpstart Our Business Startups (JOBS) Act. CFIRA is an organization formed by the crowdfunding industry’s leading platforms and experts. The group will work with the Securities & Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), and other affected governmental and quasi-governmental entities to help establish industry standards and best practices. For more information, visit www.CFIRA.org.