The Securities and Exchange Commission adopted a new rule that, effective Sept. 23, will end the ban on general solicitation to accredited investors.
General solicitation in this case refers to any contact with an investor where there was not a prior relationship of some kind. It includes any form of advertising to the general public, even one-on-one solicitations such as cold-calling. The SEC’s decision, made on July 10, is one of several provisions in the JOBS Act of 2012, designed to facilitate capital formation and will make access to potential investors easier.
“In the past, if you engaged in public advertising of an offering, you must have registered [that offering] with the SEC,” said Thomas Rutledge, an attorney in the Louisville, Ky., office of Stoll Keenon Ogden.
Rich Mains, an attorney in SKO’s Lexington office, described that registration process as “expensive and time-consuming.” The S-1 form required for such a registration can easily run hundreds of pages. Completed forms must include a narrative history of the company, which is a lengthy and onerous task to complete.
“[To avoid registration] you could sell a lot of securities, but only to accredited people with whom you’ve had prior contact,” said Rutledge.
“There has been, for many years, a safe harbor — Rule 506. If you jump through the hoops, registration is not required,” said Rutledge.
Rule 506 previously allowed raising unlimited capital from an unlimited number of accredited investors and up to 35 non-accredited investors, as long as there was a mandatory disclosure and no general solicitation. Accredited investors are those who meet minimum standards of assets and income. If there are only accredited investors, there is no mandatory disclosure.
The newly issued rules create a new exemption under Rule 506 that now allows for a general solicitation.
Under the new rule 506(c), “provided you sell only to verified accredited investors, you can publicly advertise your offering,” Rutledge said.
For instance, a manufacturing company in western Kentucky could advertise through several different channels that they are seeking accredited investors for a private offering. These advertisements could be as basic as a blurb on a website or as far-reaching as an ad in a national publication. Investors would then have to be verified by the offering promoters themselves as to their accredited status.
“Obviously, this hugely opens up the pool of investors for any particular business,” said Rutledge. He noted that the pool of accredited investors is only about 3.5 percent of the population and is fairly dispersed, making general solicitation a far more efficient way for capital formation to take place.
“It allows investors and companies that need to grow to speak to each other in a parallel track,” said Rutledge.
The breadth of general solicitation can also be focused toward specific groups of investors.
“For instance, say someone in Lexington has an idea for a new medical device. He could, with the new rules, send a letter to all doctors in the area, soliciting investors, where that was arguably prohibited in the past,” said Mains.
While the rule against general solicitation was designed to protect investors against fraudulent or misleading investments, accredited investors are likely more savvy.
“These are people who have the business acumen to know what they’re investing in,” said Rutledge. “They’re people who don’t need the protection of the registration process.”
While the new rules allowing general solicitation don’t contain any mandatory disclosure requirements, Rutledge and Mains suggested that all companies engaging in a general solicitation provide a disclosure document to protect against issues with the anti-fraud provisions of securities regulations.
Companies are also still required to make a Form D filing with the SEC for any offerings, although this specific filing is negligible in comparison to the prior registration requirement.
“It’s a short, fill-in-the-blank form. It’s not a narrative account,” Mains said.
These new rules are part of a larger set of rules that will also open the door to equity crowdfunding. Crowdfunding, of course, relies heavily on general solicitation, although it will also open the door to non-accredited investors and will come with restrictions on the amounts of funds supporters can invest and promoters can solicit.
It should, of course, be noted that this article greatly simplifies the regulations and issues at play, and any interested parties should consult counsel for greater detail on the new regulations.