Last week, the SEC approved the release of highly anticipated proposed rules to create a framework and guidelines for companies and investors seeking to engage in crowdfunding.  Crowdfunding is a relatively new method of funding that enables companies to raise capital for a wide variety of projects – from movies to scientific research – by selling small amounts of equity to a large number of retail investors, typically through the internet.  Title III of the JOBS Act carved out an exemption under the securities laws to permit  the offer and sale of securities of companies engaged in crowdfunding, and today’s proposing release sets forth the SEC’s vision for a crowdfunding market that can, in the words of SEC Chair Mary Jo White, “thrive in a safe manner for investors.”

 Read the Proposed Rules here: http://www.sec.gov/rules/proposed/2013/33-9470.pdf

SEC Summary on Rule Proposal: http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540017677#.Umg_jfmkoqw

Title III of the JOBS Act: http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf#page=10

The proposing release is almost 600 pages long, so stay tuned in the coming weeks for more detailed thoughts and analysis…..

- Sarah Chopnick    October 31, 2013


In the wake of the JOBS Act, many market players have weighed in on whether or not the SEC’s current definition of “accredited investor” should be amended.  In a report mandated by the Dodd-Frank Act and published in July 2013 (available at http://www.gao.gov/products/GAO-13-640 ), the GAO sought input from a wide range of market participants on alternatives to the current definition.  These alternatives included the introduction of an investor sophistication exam and a financial education standard as possible additions to the current test for natural persons, which focuses solely on income and net worth.  The GAO Report states that most market participants recommend that, when it conducts its review of the definition in 2014 as required by Section 413(b) of Dodd-Frank, the SEC focus primarily on adding an investment-amount minimum and use of an investment advisor as alternative means of determining accreditation.

In connection with its proposed amendments to Reg D and Form D, the SEC is currently soliciting comments on whether or not the current accredited investor definition with respect to natural persons set forth in Rule 501(a) of Regulation D should be amended (see http://www.sec.gov/rules/proposed/2013/33-9416.pdf).  The request has generated a fair amount of commentary, generally favorable to the concept of moving beyond the current financial thresholds.

 Yesterday, Representatives Patrick McHenry (R., N.C.) and Scott Garrett (R., N.J) weighed in on the issue in a letter to the SEC’s Chair White (available at http://online.wsj.com/public/resources/documents/SECAILetter10302013.pdf).  In the letter, the Representatives challenge the findings of the GAO Report and request that the SEC consider multiple objective means by which investors could meet accreditation standards, including such investors’ demonstrated financial experience in the absence of the requisite income or net worth.  The Wall Street Journal reported on these developments last night (see http://blogs.wsj.com/moneybeat/2013/10/30/lawmakers-urge-greater-investor-access-for-private-deals/).    

 The idea of determining an individual’s ability to assess the risks associated with investing in unregistered offerings on the basis of something other than the individual’s income or net worth has been discussed in multiple forums and has generally found market support, including in the Kauffman Foundation’s 2013 State of Entrepreneurship Address (see https://www.secondmarket.com/education/wp-content/uploads/2013/10/Kaufman-SOE-Report_2013.pdf).  We hope that the SEC gives serious consideration to this input as it reviews the current definition and the constraints that the current financial threshold-only definition places on the ability of financially sophisticated investors to invest in unregistered securities.

- Annemarie Tierney  October 31, 2013


I am so excited to let you know that I was given the opportunity of guest blogging on MoFo’s Jumpstarter blog today about the elimination of the general solicitation ban and SecondMarket’s great general solicitation product that includes verification of accreditation.  Check it out!

http://www.mofojumpstarter.com/


- Annemarie Tierney

September 23, 2013


Today we filed our comment letter on the SEC’s proposed amendments to Regulation D and Form D.  While I understand the Commission’s need to address the concerns raised by various investor rights organizations and state regulators in the context of lifting the ban on general solicitation, the proposed changes imply that the Commission is completely unaware of how private issuers, particularly startups, raise  capital in today’s electronic world.  As a result, many of the proposals are simply unworkable for private issuers and other proposals would impose draconian penalties for issuers that fail to comply.  I urge you to read the proposed rules and submit your own comment letters prior to the close of the comment period on September 23, 2013. 

Letter is available here: 

https://www.secondmarket.com/education/wp-content/uploads/2013/09/Reg-D-Proposed-Changes-9-18-13.pdf

 

- Annemarie Tierney 9/18/13


Wow - what a busy month July has been on the regulatory front!  On top of publication of the final rules on Rule 506 in the Federal Register today, on July 18, 2013, the GAO published a study required under the Dodd-Frank Act in which examines market participants’ views on (1) the existing criteria for accredited investor status and (2) alternative criteria. To address these objectives, the GAO conducted a literature review, examined relevant data, and interviewed domestic and foreign regulators and industry representatives to identify alternative criteria. GAO also conducted structured interviews of 27 market participants (including broker dealers (one of which was SecondMarket), investment advisers,attorneys, and accredited investors).  In its conclusion, GAO recommends that the SEC  consider alternative criteria for determining accredited investor status, including adding liquid investments and the use of a registered investment adviser as alternative criteria.  It is worth pointing out that the SEC agrees with GAO’s recommendations, noting that the Dodd- Frank Act requires the agency to review the definition of accredited investors every four years starting in 2014. The SEC said that it would consider proposing alternative criteria (particularly, adding liquid investments and the use of a registered adviser) when it completes its mandated review. 

http://gao.gov/assets/660/655963.pdf

- Annemarie Tierney


On July 10, 2013, the SEC voted to approve final rules to eliminate the decades old prohibition on general solicitation in the context of Rule 506 private placements as required under the JOBS Act.  Those final rules were published in the Federal Register today (July 24) and will be effective in 60 days http://www.gpo.gov/fdsys/pkg/FR-2013-07-24/pdf/2013-16883.pdf.  Since the SEC published its proposed rules regarding the elimination of the general solicitation prohibition on August 29, 2012, we here at SecondMarket have been very focused on developing best practices for verifying the accredited investor status of potential investors for issuers that choose to generally solicit under the new rules.  I was very glad to see that the SEC’s final rules included a non-exclusive list of methods that an issuer could use to satisfy the requirement that it take reasonable steps to verify each investor’s accreditation status (including relying on a third party broker dealer for verification), a suggestion that SecondMarket and many others offered during the comment period applicable to the proposed rules.  As we continue to work through the final parameters of the  accreditation verification product that SecondMarket will be offering to issuers once the final rules are effective in September, I invite feedback from members of the securities bar on what best practices for accreditation should be, especially around verification of net worth.  Much more to come on this topic, but a very exciting time to be in the private placement space!

- Annemarie Tierney


Our first guest blogger, Broc Romanek of TheCorporateCounsel.net notes: With the JOBS Act having its first birthday last week, crowdfunding remains a popular topic for the mass media and bloggers alike.

Here is a sampling of pieces from over the past few months:

- Broc Romanek


Last week, the staff of the SEC’s Division of Trading and Markets issued two no action letters related to online platforms involved in private placements.  In the first letter, dated March 26, 2013, the staff indicated that they would not recommend action against the operators of the FundersClub website for failing to register as a broker/dealer under the Exchange Act.  The staff issued a similar letter on March 28, 2013, to our partners at AngelList. 

These letters are well worth a read, as is this really good client alert issued by Goodwin Procter on April 2 (thanks to our friend and Goodwin partner Peter LaVigne for letting me bootleg their work!). 

Currently, the vast majority of online platforms that offer accredited investors access to private placement opportunities are registered broker dealers, such as SecondMarket.  However, Section 201 of Title II of the JOBS Act included the following provision that provides the basis for the position the Staff takes in the no action letters:

(b)(1) With respect to securities offered and sold in compliance with Rule 506 of Regulation D under this Act, no person who meets the conditions set forth in paragraph (2) shall be subject to registration as a broker or dealer pursuant to section 15(a)(1) of this title, solely because—

‘(A) that person maintains a platform or mechanism that permits the offer, sale, purchase, or negotiation of or with respect to securities, or permits general solicitations, general advertisements, or similar or related activities by issuers of such securities, whether online, in person, or through any other means;

‘(B) that person or any person associated with that person co-invests in such securities; or

‘(C) that person or any person associated with that person provides ancillary services with respect to such securities.

‘(2) The exemption provided in paragraph (1) shall apply to any person described in such paragraph if—

‘(A) such person and each person associated with that person receives no compensation in connection with the purchase or sale of such security;

‘(B) such person and each person associated with that person does not have possession of customer funds or securities in connection with the purchase or sale of such security; and

‘(C) such person is not subject to a statutory disqualification as defined in section 3(a)(39) of this title and does not have any person associated with that person subject to such a statutory disqualification.

The key provision of the section, which both FundersClub and AngelList represent that they will satisfy, is that no compensation can be received in connection with the purchase or sale of the security.  Currently, most angel investments are done via a direct transaction between the angel investor and the company raising capital.  The average investment size is around $50,000 and the angel takes shares directly in the company and pays no additional fees.  Most deal platforms are neither registered broker dealers nor investment advisors.  These platforms are built to raise capital from angel investors and have historically not earned compensation for those activities. 

SecondMarket and AngelList are currently partnered in this space and offer an indirect investment product through SecondMarket’s broker dealer and management company subsidiaries.  For the same amount of capital necessary to historically make one angel investment, our accredited investors are able to build a diversified portfolio of investments.  This will be an interesting space to watch, especially once the SEC adopts final rules to allow general solicitations in the context of Rule 506 offerings.

-   Annemarie Tierney


Happy birthday, JOBS ActOne year ago, on April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act into law during a Rose Garden ceremony.  I remember that day very clearly because Barry Silbert, our CEO, and Mark Murphy, our Head of Public Affairs, were in attendance as recognition for SecondMarket’s efforts with respect to the 12(g) registration threshold and I was super jealous that I didn’t get invited too.  During that event, President Obama made the following remarks:

“Here’s what’s going to happen because of this bill.  For business owners who want to take their companies to the next level, this bill will make it easier for you to go public.  And that’s a big deal because going public is a major step towards expanding and hiring more workers.  It’s a big deal for investors as well, because public companies operate with greater oversight and greater transparency. 

And for start-ups and small businesses, this bill is a potential game changer.  Right now, you can only turn to a limited group of investors — including banks and wealthy individuals — to get funding.  Laws that are nearly eight decades old make it impossible for others to invest.  But a lot has changed in 80 years, and it’s time our laws did as well.  Because of this bill, start-ups and small business will now have access to a big, new pool of potential investors — namely, the American people.  For the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.”

Presidential and broad bipartisan Congressional support, job creation, facilitation of capital raising under the watchful eye of the SEC - it sounded like a legislative slam dunk, didn’t it?  So why is it that a year later, only those portions of the JOBS Act that were immediately effective are in place? 

For today, let’s focus on Title II of the JOBS Act, which eliminated a decades-old ban on general solicitation in the context of private placements under Rule 506 of Regulation D, and save the crowd funding and Reg A provisions of the JOBS Act for another post, shall we? 

So why the delay on Title II?  The idea of eliminating the general solicitation prohibition in the context of private placements was far from novel.  A wide variety of market experts from the American Bar Association to the SEC’s Advisory Committee on Smaller Public Companies to the participants on the SEC’s annual Forum on Small Business Capital Formation had been supporting relaxation of the ban in one form or another since the late 1990s.  The SEC itself proposed a similar change for private offerings of “large accredited investors” back in 2007, amendments that were ultimately not approved, and various members of the SEC’s staff have been stating publicly for years that the Commission understood the need to revisit the prohibition in light of technological changes around communications

The problem for President Obama, Congress and issuers waiting for the ability to more easily locate accredited investors in order to raise badly needed capital is that the actual language of the JOBS Act made the elimination of  the ban on general solicitation contingent upon SEC rulemaking, as follows (I added the bold):

Not later than 90 days after the date of the enactment of this Act, the Securities and Exchange Commission shall revise its rules issued in section 230.506 of title 17, Code of Federal Regulations, to provide that the prohibition against general solicitation or general advertising contained in section 230.502(c) of such title shall not apply to offers and sales of securities made pursuant to section 230.506, provided that all purchasers of the securities are accredited investors. Such rules shall require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.

Based on the clear language of the JOBS Act, these rules should have been in place by early July 2012, at the latest.  Instead, a year later, the SEC is still considering comments that were submitted on rules that were not even proposed until August 29, 2012.   Checking the SEC’s website today, I was surprised to see that comment letters are still being submitted on these rules, even though the comment deadline was October 5, 2012, but was not surprised that the majority of these letters ask the SEC to take action to implement the proposed rules.

So what is the SEC waiting for?  You would think that six months is long enough to distill the public comment letters, however numerous, received on the proposed rules.  I’d also note that any number of Congressional members have written letters to the Commission urging it to adopt the proposed rules, and that the House Committee on Oversight and Government Reform even launched an investigation to see why the SEC issued proposed rules versus interim rules that would have had immediate effect.  You should read the letter that Congressman McHenry sent to Chairwoman Mary Shapiro following that investigation and related hearings; it provides some real insight into the Commission’s inner workings. 

During her testimony before the Senate Banking Committee last month,  Mary Jo White, expected to be confirmed shortly as the next Chairwoman of the Commission, testified that she will work with the staff and Commissioners to “finish, in as timely and smart a way as possible,  the rulemaking mandates contained in the Dodd-Frank Act and the JOBS Act.”  I don’t envy her task with the pending departures of Commissioners Elisse Walter and Troy Paredes, but I hope, for the sake of the private issuers waiting for the ability to raise capital under these long overdue provisions, that I am not writing about this same topic a year from now. 

-    Annemarie Tierney


As a securities lawyer focused on SEC-registered offerings, prior to joining SecondMarket, I had little need to develop anything more than a passing knowledge of state blue sky laws – thank you Section 18!!  In the private issuer secondary transaction space, however, making sure that sellers satisfy blue sky rules in the states where buyers are located is just as important as identifying which federal exemption sellers can rely on in the context of the sale.  Over the course of the last year, we have spent a significant amount of time mapping out the non-issuer exemptions available in each state and the results were eye opening.  We distilled the information into this comprehensive report that we presented to the North American Securities Administrators Association (NASAA) earlier this year.   In addition to our 50 state survey results, we also presented NASAA with language for a proposed nationwide exemption that would put all 50 states on equal footing when it comes to non-issuer private transactions. 

Why should the states give serious consideration to adopting a truly standard nationwide exemption?  First of all, with the change to the 12(g) registration threshold adopted as part of the JOBS Act, more companies are going to choose to stay private longer, if not perpetually.  Their shareholders, including employee shareholders, on the other hand, are going to want liquidity for their shares at various points in time.  To the extent that specific state blue sky laws restrict or limit non-issuer sales thereby limiting liquidity, investors are less likely to invest in a company in that state and employees are less likely to see value in equity compensation.   In addition, states that make it difficult for shareholders to sell private issuer securities potentially forfeit the income and capital gains tax revenue that becomes payable when options are exercised and common or preferred stock is sold.  And states that make it difficult for sellers or broker dealer intermediaries to locate potential buyers put their residents at a disadvantage compared to other state’s residents when it comes to investing in private companies. 

We see these issues played out in real life each time we work with a private community bank or other issuer to implement a private liquidity program for shareholders.  For example, many community banks choose to limit approved buyers to investors located in the bank’s home state or in states contiguous with that state due to the local nature of their business.  In the context of each new program, we need to identify whether the bank’s home state law allows all shareholders to sell (some states make it very difficult for or restrict the ability of affiliates to sell their shares) and which non-issuer exemptions are available in the jurisdictions in which we want to locate buyers.   We often end up needing to preclude buyers from certain states from participating in a given program due to inconsistencies with the other target states’ requirements.  Making it easier for issuers such as community banks to offer ongoing liquidity to their shareholders in the context of a “one size fits all” regulatory framework will make it easier for that bank to raise new capital and invest back into local businesses.   A win-win situation.

We have been very encouraged by our conversations with NASAA to date and expect to have much more to report of this topic going forward.   And admit it, I sound a little like a blue sky lawyer right now, don’t I?  Pretty cool.

-  Annemarie Tierney