The SEC announced that the next meeting of the Investor Advisory Committee will be held on October 9, 2014. The public may submit written comments or statements. The agenda for the meeting includes a discussion of recommendations regarding the definition of “accredited investor.”
We continue to wait for the SEC to issue final crowdfunding regulations— the comment period ended in January. Meanwhile, some states have sensed an opportunity. Section 3(a)(11) of the Securities Act exempts “intrastate” offerings from the Securities Act when the securities sold are part of any issue “offered and sold only” to persons resident within the specified state where the issuer is resident in or incorporated by, and doing business within, such state. SEC Rule 147 provides objective standards for determining eligibility for the exemption under Section 3(a)(11). Securities offered pursuant to Section 3(a)(11) are not considered “restricted securities” under the Securities Act, and neither Section 3(a)(11) nor Rule 147 prohibits “general solicitation” or “general advertising.” The primary concern for an intrastate offering is that it must be structured not to offer the proposed securities to non-residents.
Relying on the Section 3(a)(11) exemption, a number of states have recently implemented their own crowdfunding provisions, additional states are considering it, and a few states have determined not to implement such regulations. Each state that addresses crowdfunding has a maximum investable amount per investor and total offering size. Although crowdfunding is often associated with the offering of securities through use of an Internet portal, only two states—Indiana and Wisconsin—require that such offering be made exclusively through an Internet portal, while the remainder either state that the use of an Internet portal is allowed (but not necessarily required) or remain silent regarding the use of an Internet portal in executing an offering under the exemption. Each state also may require specified acknowledgments from the investor and differing levels of disclosure. At this time, none California, Delaware, Florida, Massachusetts, Nevada or New York has publicly indicated that it is considering intrastate crowdfunding legislation. It is also not clear how having up to 50 different state regimes will necessarily help the crowdfunding industry develop standardized processes that could make crowdfunding easier for startups.
We attach for your use a summary of the current state crowdfunding regulations with links to the statutes or regulation here: http://www.mofo.com/~/media/Files/CapitalMarkets/140919SummaryofCurrentStateCrowdfundingRegulations.pdf
SEC Commissioner Daniel Gallagher urged the commission on Wednesday to fulfill its mandate to promote capital formation. The SEC should institutionalize an enhanced small business focus, Gallagher said in his prepared remarks, because its current small business mandates are “generally treated as afterthoughts on the ‘back end’ of the rulemaking process.”
Gallagher challenged the SEC to enhance its ability to review and update existing regulations that have been on the books for decades. He added: “We almost never consider how heavily the weight of the entire corpus of rules bears down on registrants. Only rarely do we remove any of our rules even after they have long since ceased to serve their purpose or have become obsolete or worse.”
In making his recommendations, Gallagher suggested that the agency create an Office of the Small Business Advocate, modeled after the SEC’s Office of the Investor Advocate. It would report to the commission and “take charge” of the SEC’s Advisory Committee on Small and Emerging Companies and the Government-Business Forum.
The portion of the commissioner’s remarks on regulatory process maps closely to issues we at the Milken Institute Center for Financial Markets (CFM) are exploring through our new FinTech: 21st Century Market and Policy Developments program. We are considering alternative regulatory approaches that would enhance coordination and regulatory agility while allowing regulators to more effectively satisfy their investor protection and capital formation objectives. These models might rely on increased use of pilot programs, aggregation and analysis of data and outcomes, and more frequent iteration in the rule-making process. Already, we are seeing some of these methods deployed through the Consumer Financial Protection Bureau’s Project Catalyst, as well as the SEC’s implementation of its Tick Size Pilot Plan.
With respect to specific medium-term recommendations for promoting capital formation in private markets, Gallagher suggested:
- Withdrawing additional proposed Regulation D rules tied to Title II of the JOBS Act. The proposal “does more harm than good,” Gallagher said, noting that it would stifle private markets “while achieving no clear offsetting investor protection goals.” See the CFM Comment Letter on Amendments to Regulation D.
- Broadening the blue-sky exemption under Regulation D. The exemption should be broadened to provide greater choice between Rule 504, 505 and 506 offerings, because “99% of the capital raised under Regulation D is pursuant to the Rule 506 exemption” due to the fact that Rule 506 offerings are blue-sky exempt.
- Improving secondary-market liquidity. The creation of additional “facilities” to improve liquidity and innovation in the secondary marketplace, as well as a review of resale rules, would go a long way toward increasing secondary-market activity.
Among his list of recommendations for the public markets, Gallagher included:
- Implementing crowdfunding. Gallagher said crowdfunding should not be treated as a “curiosity,” adding that if the rule is unworkable, the SEC “should be loudly telling Congress that we need a legislative fix.” SeeCFM’s Comment Letter on Regulation Crowdfunding.
- Implementing Regulation A+. Gallagher called responses from state regulatory officials “disappointing,” adding: “I simply do not understand why a federal registration and review regime – tailored for smaller companies but nonetheless comprehensive – that does not divest states of their antifraud enforcement authority, should be viewed as representing a threat to investors.” Gallagher proposed two amendments to Regulation A+: Increase the size of offerings from $50 million to $75 or $100 million, and exempt Reg A+ shares from Section 12(g) of the Exchange Act. See CFM’s Comment Letter on Regulation A+.
- Scaling Disclosure Requirements. Gallagher said the JOBS Act “was a floor… not a ceiling,” and advocated for replacing current scaled disclosure requirements for a “small reporting company” with a two-tier system of scaling for “nanocap” and “microcap” companies. The two-tier scaling structure would provide “significant scaling” for nanocap companies of up to $50 million in capitalization, with more moderate scaling for microcap companies with capitalizations between $50 and $300 million. See How the Feds Can Save the IPO Market.
Daniel Gorfine is the director of financial markets policy and legal counsel in the Washington office of the Milken Institute. He focuses on entrepreneurship, capital access, and financial market issues.
Jackson Mueller is a policy research analyst at the Milken Institute’s Center for Financial Markets. His focus is on capital formation policy and financial markets education initiatives.
This post was originally featured on the Milken Institute’s blog, Currency of Ideas, available at: http://www.milkeninstitute.org/blog/view/660
Join Morrison & Foerster on October 8, 2014 for our Developments in Private Placements seminar, a part of our MoFo Classics Series. During this session we will provide a brief update of Rule 506 and Rule 144A, as amended as a result of the JOBS Act, and discuss the special concerns that issuers, placement agents, existing investors and others may have in connection with private offerings. We will address the CFTC’s relief for funds that seek to use general solicitation, and discuss investor verification, including best practices. We also will discuss how different participants are using accredited investor crowdfunding and matchmaking sites.
Morrison & Foerster is offering participants 1.25 New York CLE credits for attendance.
To register for the event, please email Harrison Lawrence at firstname.lastname@example.org.
The House of Representatives voted 320 to 102 to pass H.R. 5405 (Promoting Job Creation and Reducing Small Business Burdens Act) that contains a number of JOBS Act related measures that previously were the subject of individual bill proposals. For example, the bill addresses the JOBS Act inadvertent failure to address the Exchange Act threshold as to savings and loan holding companies; a pilot tick-size pilot program for emerging growth companies; a grace period for transitioning from EGC status; and an exemption from xBRL requirements for EGCs.
Issuers, placement agents and attorneys have been working with the new Rule 506(d) “bad actor” provisions for almost one year. Our Client Alert summarizes recent SEC guidance in this area, and provides some practical tips on how to identify any bad actors in advance of a Rule 506 offering. We also take a look at the waivers from disqualification that the SEC has granted upon a showing of good cause.
Today, the SEC and SBA announced they will jointly host events to inform small business owners and entrepreneurs about new options that are and will become available for capital raising under the JOBS Act. The first event will be hosted by the University of Baltimore and held on September 25 from 2:00 – 4:00 p.m. Details are available on the SEC website. See: http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542964443#.VBi2laXD-nB
In the last few days, we received a few inquiries regarding our prior post on the CFTC’s temporary relief permitting funds to engage in general solicitation to the text that the funds were conducting Rule 506(c) offerings or relying on Rule 144A for resales. Following the SEC’s amendments to Rule 506 and Rule 144A, many funds had anticipated that they would be able to communicate more freely on a regular basis about their business and performance results. For example, many expressed a desire to make more information generally available on fund websites rather than behind password-protected walls. Others hoped that they would be able to have more flexibility in making presentations at conferences. These general discussions might or might not be viewed as “general solicitations.” As we have previously discussed, the type of communications that may be viewed as “general solicitations” is potentially quite broad and funds might engage in capital-raising activities with some frequency. Even if a fund was closed to new investments, a general communication on a website or at a conference (as opposed to a targeted or bilateral communication with an investor with which the fund had a pre-existing relationship) might well, in hindsight, be viewed as a general solicitation for an upcoming raise. As pointed out in our blog post, the CFTC relief quite specifically addresses instances in which a fund states affirmatively in its communication to the DSIO of the CFTC that it is engaging in a “general solicitation” in connection with a Rule 506 offering. A fund may be reluctant to file such a letter if a Rule 506 offering is only a possibility. There are no real communications safe harbors available to a fund, so, in the absence of amendments to the Part 4 rules, more regular communications may be limited.
The CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO) issued a no-action letter that provides exemptive relief until the CFTC takes action on JOBS Act related amendments to its Part 4 Rules. Access the letter here: http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-116.pdf
Since the SEC adopted final rules relaxing the ban on general solicitation in certain offerings made under Rule 506 and under Rule 144A, funds that are considered commodity pool operators (CPOs) as a result of their engaging in swaps activities and funds that relied on an exemption from CPO registration were left to wonder whether the CFTC would amend its regulations that currently prohibit marketing to the public.
For example, under Regulation 4.7 CPOs are relieved of certain reporting requirements provided that their securities are sold in a Section 4(a)(2) offering or in the case of banks registered as CPOs in connection with collective trust funds the securities of which are “offered or sold, without marketing to the public” to certain qualified investors. Without relief, an entity would not be able to rely on the provisions of Regulation 4.7 if it were to undertake a Rule 506(c) offering. Similarly, under the CFTC’s Regulation 4.13 (referred to as the de minimis exemption from CPO registration), an entity that claims the exemption must offer and sell interests without marketing to the public.
Therefore, the CFTC’s DSIO’s letter provides relief for CPOs that choose to use Rule 506(c) offerings or relying on Rule 144A resales. A CPO that claims exemptive relief must file a notice with the CFTC that includes certain basic information. The notice requirement is intended to permit the CFTC to verify compliance and to gain an understanding of the use of general solicitation by funds. The CFTC would still be required to amend its Part 4 Rules to effect a more permanent solution to reconcile its rules with the new reality of general solicitation.
In June 2014, the SEC ordered the national securities exchanges and FINRA to develop and file a proposal for a tick size pilot program. On August 26, 2014, the SEC announced that the national securities exchanges and FINRA had filed a proposal to establish a national market system plan to implement a targeted 12-month pilot program that will widen minimum quoting and trading increments (tick sizes) for certain stocks with smaller capitalization. The SEC indicated that it plans to use the pilot program to “assess whether such changes would enhance market quality for smaller capitalization stocks for the benefit of investors and issuers.” The proposed plan is subject to SEC approval following a 21-day public comment period.
As proposed, the pilot program will include stocks with a market capitalization of $5 billion or less, an average daily trading volume of one million shares or less, and a closing share price of at least $2 per share. The pilot will consist of one control group and three test groups, with 400 securities in each test group selected by stratified sampling.
- Pilot securities in the control group will be quoted at the current tick size increment of $0.01 per share, and trade at the increments currently permitted. The control group would represent a baseline for analysis during the pilot period.
- Pilot securities in the first test group will be quoted in $0.05 minimum increments. Trading would continue to occur at any price increment that is permitted today.
- Pilot securities in the second test group will be quoted in $0.05 minimum increments, and traded in $0.05 minimum increments subject to certain exceptions.
- Pilot securities in the third test group will be subject to the same minimum quoting and trading increments (and the same exceptions) as the second test group, but in addition would be subject to a “trade-at” requirement, which prevents price matching by a trading center that is not displaying the best bid or offer.
The pilot also directs the exchanges and FINRA to collect and transmit data to the Commission and make the data available to the public in an agreed-upon format. After the end of the pilot period, the exchanges and FINRA will complete an assessment of the impact of the pilot and submit the assessment to the SEC.