July 25, 2013
By a remarkable coincidence, I happened to make my only comment on the then proposed, and long-delayed, General Solicitation Rule on the very same day that it was finally adopted. As a result, that comment (which was admittedly untimely according to the Comment Period set forth in the Proposing Release) has not been posted. As it turns out, however, the adoption of the General Solicitation Rule has provided an opportunity to reframe that original comment in the context of the new complementary rule proposals.
The original comment was that the Commission should condition the availability of general solicitation in Rule 506 offerings on the involvement of an SEC registered broker dealer in the offering. The thinking was that the best method of ensuring compliance with the accredited investor standards in unregistered offerings and minimizing antifraud violations in the solicitations themselves would be to require the participation of a broker-dealer subject to state and federal regulatory oversight, not to mention having established compliance procedures and a well-founded fear of being held vicariously liable for any violations of law in the offering. In addition, the original comment noted that one of the biggest impacts of the new General Solicitation Rule is likely to be an adverse economic impact on the business of smaller broker-dealers, whose business often consists of solicitations of investors in unregistered offerings. These smaller broker-dealers often depend upon the "customer lists" of accredited investors with whom they have a "pre-existing business relationship" that have permitted them to avoid general solicitation prohibitions in traditional private placements.
The Commission's new rule proposals, while ostensibly designed to "enhance the Commission's understanding" of the private capital market process after the adoption of Rule 506(c), do in fact provide an opportunity for the Commission to correct the mistake it made in adopting the General Solicitation Rules without including a requirement for the involvement of a registered broker-dealer. Before specifically addressing how to integrate such a requirement with the Commission's new rule proposals, however, a brief comment on the existing proposals is warranted.
The proposals to require the filing of an Advance Form D, an amended Form D at closing, to disqualify issuers who have previously failed to make appropriate Form D filings, to put legends on written general solicitation materials and to limit the use of historical performance data are all demonstrative of the Commission's "ivory tower" understanding of the enormous impact that the new General Solicitation Rule is about to have. These lawyerly proposals are like shooting spitballs at a battleship; they will be totally ineffective in terms of reducing the risk of fraud on investors, which is obviously the greatest risk of new Rule 506(c). On September 23, there is going to be an unprecedented onslaught of emails, advertisements and other forms of general solicitation for a host of dubious and potentially fraudulent investments. The legal niceties of Form D and the Commission's other myopic proposals will be largely irrelevant.
What is needed is a substantive mechanism to manage, or at least monitor, the offering process in Rule 506(c) offerings; everything else that has been proposed is just sound and fury, signifying nothing.
Fortunately, there is one aspect of the proposed rules that could meaningfully reduce the risk of fraud in Rule 506(c) offerings--the proposed requirement that written general solicitation materials be filed with the Commission under proposed temporary Rule 510T. While I recognize that this rule is also likely to elicit the most negative comments, as issuers will be understandably wary of the use of these materials by the Commission, it is also the opportunity for the Commission knew those criticisms while correcting the mistake it made in adopting the General Solicitation Rule in the form it did. The Commission can provide an exemption from the written solicitation materials filing requirement for those offerings that involve a registered broker-dealer. The logic, of course, is that the registered broker dealer will be a far better monitor and manager of the offering process and the adequacy of the disclosures in the written materials than the Commission, with its limited resources, could ever be.
As noted above, the Commission should also be cognizant of the enormous negative financial impact of the new General Solicitation Rule on hundreds of smaller broker-dealers. Based on the Commission's actions, those registered broker-dealers apparently do not have a significant voice on Wall Street, with the Commission, with FINRA or even with their own industry associations. But there is absolutely no doubt that they will be devastated by the new Rule unless the Commission promptly amends the Rule, or adopts a new rule, that reinstates their vital role in the capital raising process for their historic small business clients. From its actions, and the myopic economic analysis that accompanied those actions, it seems obvious that the Commission remains oblivious to the critical role that these small broker-dealers have played in the "grass roots" capitalization of American small businesses. It is not too late to wake up.
Moreover, a solution that promises to dramatically reduce the incidence of fraud in Rule 506(c) offerings and simultaneously protects the hundreds of businesses and jobs of currently registrants with the Commission is unlikely to be actively opposed by any known constituency, irrespective of their economic perspective or political persuasion. The Commission has an opportunity to harness a tremendous resource, the backbone of the self-regulatory system it supervises, by cementing the role of registered broker-dealers in the Rule 506(c) offering process, and it should make every effort to do so on or before September 23, 2013. The potential victims of the unbridled general solicitation process that is about to be unleashed on the American public demand that the Commission not only make such an effort but succeed.
For the cynical who may assume that I have an economic interest in one or more of broker-dealers, as clients or otherwise, I assure you that I do not, and that the representation of registered broker-dealers is a very small part of my law practice and of the practice of my law firm. My motives are simply to try to head off the chaos and fraud that the new Rule is about to unleash.
Davis Graham & Stubbs LLP