SEC Proposes Restrictive Rules on the Same Day It Finalizes General Solicitation

After almost a year of delay, on July 10, 2013, the SEC adopted final rules to implement Title II of the JOBS Act and allow general solicitation and advertising under Rule 506. The final rules, effective September 23, 2013, are a practical implementation of the JOBS Act. They will allow issuers to advertise offerings and generally solicit investors while implementing meaningful, but manageable, checks against potential abuses. See here for a more detailed discussion of the new Rule 506(c) offerings.

But the proposed rules released the same day might make Rule 506(c) offerings more trouble than they are worth. The proposed rules, which were not mandated by Congress in the JOBS Act, would impose a number of conditions on companies using Rule 506(c), the most significant of which are briefly discussed below.

First, under the proposed rules, a company would have to file Form D fifteen days before the first general solicitation or advertising. Currently, Form D must be filed within 15 days after the first sale. This requirement could stifle normal deal flow, where a company is often negotiating with a lead investor right up until the closing and then immediately following up with follow-on investors. Companies would have to adapt, and there are two obvious solutions.

A company could choose its own terms and publicize them, without the benefit of having had a back-and-forth with an investor. But encouraging companies to offer non-market terms to the public hardly seems to serve the public interest. Another solution would be for a company to negotiate the round with a lead investor, file Form D, and then wait 15 days to advertise the offering. Again, this makes little sense.

The proposed rules would also mandate the use of legends on every single written general solicitation material. Investors must be apprised of the risks. But it is unclear whether mandating legends on every single written material is designed to accomplish that. Advertisements are not designed to be a complete and thorough explanation of the entire product. They are meant to solicit interest and further investigation. How many people even read the fine print at the bottom of advertisements? It seems informing investors of risks would be better achieved by clearly explaining those risks at a time in the transaction when the investor is actually likely to read and comprehend them. As written, this rule does nothing but impose a burden on companies, and potentially prohibits communications in certain media (e.g. Twitter, where communications are limited to 140 characters).

Also troubling is the proposed rule that companies would have to submit every written general solicitation material to the SEC prior to publicly disseminating it. Ostensibly, this temporary, two year rule would only be to allow the SEC to assess market practices under the new Rule 506(c). But the SEC also mentions that it could be used to further investor protection. If the SEC does not propose to review all of the submissions, how could this requirement protect investors? And what would companies have to submit? Verbatim copies of all communications every time they are sent? Templates that the company can modify? The failure to comply could lead to harsh consequences, including the inability to rely on Rule 506, and would eviscerate all its benefits.

Finally, any failure to comply with Form D filing requirements would automatically disqualify a company from using Rule 506 for one year. Surely, the SEC could do better than this. Compliance is a serious matter, but inadvertently filing a day or two late does not merit disqualification for one year.

These rules are only proposed, but they highlight that they, or some other rules, could seriously impede the progress that has been made in opening up capital markets for small companies. With luck, the SEC will not approve these rules and will stick to leaner, smarter regulations that are actually designed to protect investors instead of imposing unnecessary burdens on already-struggling companies.