Free Accredit Report.com – JOBS Act creates a new pivot for your dotcom
In an earlier post, The Craigslist Exemption, I described the changes mandated and expected that arise from the new JOBS Act signed into law on April 5. One of those upcoming changes is the ability to engage in general solicitation and general advertising under a Reg D, Rule 506 private offering of securities, so long as all purchasers are accredited investors. The SEC has long allowed companies to sell to sophisticated purchasers who meet the definition of “accredited investor” without going to the expense of a formal SEC-registered public offering, but wouldn’t permit any kind of mass marketing because that might lead to unsophisticated retail investors buying shares in the secondary market or worse, intentional efforts to sell to the general public using accredited investors as willing conduits.
Congress felt that the status quo prohibition on general solicitation and advertising made it overly difficult for companies to connect with sophisticated investors, putting an artificial limit on access to funding by young companies. Without the ability to advertise, companies could only sell to someone already known to the investment community which was effectively shut to outsiders. If you had to ask how to invest in a private securities offering, you were presumptively on the “outside.” In addition to that problem, having a closed network of accredited investors meant that brokers, dealers and others in the financial industry could grant favors and engage in other forms of rent seeking before admitting new accredited investors to the club. So, Congress has directed the SEC to permit general solicitation and general advertising so long as all purchasers are accredited investors. There is now a mini-firestorm in progress about how the SEC should interpret the Congressional directive. Joe Wallin’s Startup Law Blog gives a good overview.
Accredited investor definition
Congress seems to have required a strict binary standard: purchasers are either accredited or not. If they’re not, then your company cannot rely on Rule 506 and may have violated the securities laws. This is a potentially serious problem for anyone trying to use Rule 506 and is also discussed in my earlier post. A large camp of securities practitioners militates for a “reasonable belief” standard: if you reasonably believe that your purchasers are “accredited,” then you should be able to use Rule 506 even if it turns out you were wrong.
This is a vital question but perhaps we lawyers are getting over-excited. The current definition of “accredited investor” (from Rule 501) already incorporates a reasonable belief standard:
“Accredited investor shall mean any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:” (my italics).
So, a reasonable belief means that the purchaser is, in fact, an accredited investor even if he or she does not actually fall within the listed categories. Some commentators have pressed the SEC to add an additional reasonable belief standard outside the accredited investor definition. In essence, general solicitation and advertising would be allowed where the company reasonably believes that the company reasonably believes that the purchasers fall within the listed categories. This is probably a non-starter for the SEC because the JOBS Act does require that all purchasers be accredited investors. But there should be no cause for alarm so long as a reasonable belief standard remains right where it is in the definition. Much more interestingly, the JOBS Act has opened up a new boom industry in investor asset verification. Is your dotcom ready to pivot?
Apparently anticipating this whole debate, the JOBS Act further directs the SEC to specify methods that companies can take to verify that purchasers are accredited investors. It seems likely that the SEC will make its verifications mandatory, at least where general solicitation and advertising are used – in other words, a “reasonable belief” will not be warranted unless specific steps are followed. What are those steps?
We don’t know yet, although we do hope that the rule will not be “overly prescriptive” as the New York City Bar Association puts it in their comment letter to the SEC. One clue to SEC thinking comes from a talk given by Lily Brown, SEC Senior Special Counsel to the Director who opined (speaking solely for herself and not for the SEC) that companies will need to do more than they do under current practice. Current practice is essentially twofold: (1) rely on the brokers and dealers to make offers only to their contacts “in the know” and who they have some familiarity with from past transactions, and (2) insist that those investors make a representation to the company (essentially a promise) that they meet the definition of “accredited investor.” Commentators are pressing the SEC to accept current practice as sufficient, but what if more is needed? Leaning again on Joe Wallin, “Presumably this means that issuers are going to have to request documentation from investors demonstrating their incomes or net worth, such as tax returns, net worth statements prepared by third party accountants, bank statements, brokerage account statements, etc.”
And there’s your next pivot. Filtering accredited investors through a third party asset verification service would limit sales to people who first affirmatively sign up and “opt in” to the brave new world of accredited investing where U.S. securities laws afford much more limited protection. The service would take on the tedious and time-consuming process of obtaining client consents, credit reports, bank statements and the like. The existing industries that I see best situated to move into the field are the credit rating agencies, credit reporting services, credit score reporting services, financial aid services, such as The College Board’s CSS service, and any nimble dotcom that can move quickly enough.
Naturally, this remains hypothetical until the SEC issues rules for comment, receives comments and issues final rules. Anything could happen. However, it seems likely that a market that will soon be able to leverage technology to unleash the private offering market at last, will be permitted to rely on a technology-based verification service.
Are you ready to take this on? Feel free to submit your own comment to the SEC here in favor of a technology-based third-party verification system. I’ll even help you write it up.