The SEC and Small Capital Formation: General Solicitations and Private Placements (Part 2)

Small capital formation is an important area that requires constant reexamination.  After all, the central system for regulating capital raising was put in place in the Securities Act of 1933, long before the invention of cell phones, email blasts and the Internet.  Technology alone, therefore, necessitates constant reexamination.  

The committee has been relatively active, having met three times so far:  Oct. 2011, Jan. 2012 and Feb. 2012.  The Committee has looked at a number of tough issues, including crowdfunding.  The Committee has, so far, issued one recommendation.  The recommendation relates to the relaxation of the general solicitation requirement for private placements.  The recommendation provides that:

the Commission take immediate action to relax or modify the restrictions on general solicitation and general advertising to permit general solicitation and general advertising in private offerings of securities under Rule 506 where securities are sold only to accredited investors.

General solicitations are, in general, prohibited under Regulation D.  The big exception is in Rule 504, the seed capital exemption.  General solicitations can be made under the rule if the offering meets certain requirements under state law.  17 CFR 230.504. 

General solicitations facilitate capital raising by allowing companies to mass market an exempt offering, thereby locating the largest number of potential investors in a cost effective way.  The tension in the area, however, is that the same mass marketing techniques can also facilitate fraudulent offerings.  Who hasn't received an email suggesting great things about a penny stock.  Similarly, pump and dumps generally require some type of general solicitation to succeed.  For more on this, see Seed Capital, Rule 504 and the Applicability of Bad Actor Provisions.   

One way to take this tension into account is to allow for general solicitations in some cases but take other steps designed to minimize the possibility that the exemption will be used for improper purposes.  The SEC has a rule proposal outstanding that would do that by extending bad actor disqualifications to offerings under Rule 506.  See Securities Act Release No. 9211 (May 25, 2011).  To the extent these proposals are adopted (something more or less mandated by Dodd-Frank), any relaxation in the general solicitation requirements under Rule 506 will be done in conjunction with restrictions on the use of the authority by recidivists and other bad actors.

Thus under this model general solicitations will facilitate capital raising by legitimate companies while bad actor provisions will ensure that recidivists who violate the rule will be prohibited from using it.  We will discuss a few of the implications of this approach in the next post.

For more on this topic, see Seed Capital, Rule 504 and the Applicability of Bad Actor Provisions.     

J Robert Brown Jr.