September 8, 2013
Re: Comments on Proposed Rule: Amendments to Regulation D, Form D and Rule 156 under the Securities Act
[Release Nos. 33-9416, 34-69960, IC-30595; File No. S7-06-13]
This comment is in response to recommendations made by Guzik & Associates in comments dated August 28, 2013 and published here:
Guzik & Associates have urged that "small businesses" as defined by the Regulatory Flexibility Act of 1980 (the "RFA") should be exempt from the proposed Rule 507(b) which would bar offenders who violate the Commission's Rule 503 from relying on the registration exemption under Rule 506 for future Offerings for a period of one year from the date that Rule 503 compliance is achieved during an Offering in which the violation occurred.
Whatever the final rules end up being, "small businesses" as defined by the RFA clearly cannot be exempt from the Rule 507(b) disqualification.
I have made my own recommendations, dated September 4, 2013 and published here:
At the very least, all issuers, regardless of size, must be required to file an Advance Form D, or, if the Commission merges the proposed concept of the Advance Form D with the initial Form D and requires an initial Form D filing coincident with the commencement of any Rule
506(c) then all issuers must be required to file the initial Form D.
If the Commission does not require, and enforce strictly, at LEAST the Form D filing requirement prior to the commencement of general solicitation and advertising of unregistered securities, under the pretext that "small businesses" would be unduly burdened by the requirement to file at LEAST an initial/advance Form D, then there will be no Form ID on-file with the Commission that purports to identify at least one authentic human person who is responsible for the unregistered public offering.
If the Commission imposes no minimum requirement for advance notice and forensic identification of at least one authentic human person then Rule
506(c) will, without a doubt, be utilized fraudulently and on a massive scale.
Remember the giant sucking sound that Ross Perot thought everyone would hear when all of the jobs in the United States went to Mexico because of NAFTA? The giant sucking sound predicted by Ross Perot would, if the SEC provides an exemption for purported "small businesses" as recommended by Guzik & Associates, perhaps turn out to be the sound of the new SEC-approved bank account vacuum cleaner as it sucks every last dollar out of the accounts of new capital fraud victims and into the bank accounts of unknown perpetrators who would never even be required to falsify any Form ID filing with the Commission in order to engage in their acts of capital fraud. See:
A Form ID filing requirement (which, as the Commission knows, is a procedural requirement of any Form D filing) is obviously not, currently, an adequate and reasonable safety measure, alone, to stop the new SEC-approved bank account vacuum cleaner from sucking money out of investors' bank accounts and transferring it to offenders. However, without at LEAST this filing requirement the Commission will have NO AUTHORITY WHATSOEVER TO TAKE ANY ACTIONS AT ALL against purported "small businesses" until and unless the Commission, or a law enforcement agency, becomes capable of making a prima facie case for fraud in court.
The simple act of raising capital using general solicitation and advertising in the United States, without first filing a Form ID and a Form D with the Commission, should be investigated aggressively as the serious criminal offense that it potentially is when the purported issuer has no true intention of attempting to create economic value that will be shared with the "investor" victims.
Reasonable safety measures must be implemented by the Commission.
Everyone knows that a "small business" is often nothing more than an idea. Even when ideas have successfully raised less than $5,000,000.00 of capital, and even when these ideas are already producing small amounts of revenue, and even when accountants, attorneys and auditors have signed off on those assets and revenues, the Commission knows that "small businesses" which raise their capital from the public are frequently fraudulent schemes.
In the past, the Commission has attempted to differentiate legitimate "small businesses" from highly-suspect ones using language and statutory concepts such as "blank check company" and "shell company" and "former shell company" so that the Commission, law enforcement agencies, and the courts could focus special enforcement attention on such highly-suspect issuers whenever such "small businesses" engage in public offerings or successfully develop a secondary market for their securities.
Although it would be wrongful and absurd, and also unconstitutional, for the Commission to prohibit a "blank check company" or a "shell company"
or a "former shell company" to utilize Rule 506(c) to lawfully and legitimately form new capital and become something substantial and real in the economy, the Commission cannot ignore the reality that there is a difference between "small businesses" that have been in existence, generating legitimate revenue, for a period of time, and every startup company that does not yet have substantial operations or non-cash assets. See:
The issue of anonymous "shell company" fraud has been receiving substantial international law enforcement and regulatory attention in recent years, including by the Commission itself. See, for example:
In my opinion, the Commission could have solved the entire problem with general solicitation and advertising, and shell company fraud, many years ago simply by creating a "public startup company" exemption that would have permitted legitimate startups to file, or have filed on their behalf, a Form 15c211 and to receive approval from FINRA to initiate a public quote for their unregistered securities through a broker/dealer.
Upon FINRA approval, such "public startup company" issuers could have, and should have, been permitted to conduct public offerings of unregistered securities in precisely the manner now required by the JOBS Act.
Because the Commission was asleep at the wheel as this opportunity to solve a serious criminal law enforcement problem and to simultaneously open the door to capital formation by legitimate "small businesses" as defined by the RFA passed by without reasonable effort by the Commission to solve these systemic problems, Congress found it necessary to pass the JOBS Act and thereby to bypass and circumvent the established Over The Counter markets entirely for such early-stage "microcap" issuers. It is not yet clear whether this is a good thing or a bad thing, on balance, and most observers expect the Commission and/or Congress to repeal the JOBS Act after a few years of (seemingly-willfully) screwing up the implementation, just as the Commission has (seemingly-willfully) screwed up the American public financial markets with its past failures and its politics.
Rather than declaring "small businesses" to be exempt from Rule 507(b) and rather than declaring "shell company" or "former shell company" or "blank check company" or other pre-revenue "startup company" issuers to be ineligible for Rule 506(c) (such as because a "startup company" or a "shell company" is not yet a "small business" as defined by the RFA) it is my view that the Commission should implement reasonable forensic safety measures to ensure, regardless of how well-established or how well-defined a "microcap" company may be at a given point in time, that ALL would-be criminals who attempt to commit capital fraud by purported to seek to raise seed capital, or "angel" investment, can be efficiently and reliably caught and prosecuted when they engage in general solicitation and advertising of their frauds.
In practice, exempting "microcap" and "startup company" and "shell company" issuers (and other types of companies or ideas that are not yet well-established and are seeking seed capital or co-founders) from the potential disqualification of Rule 507(b) but permitting such issuers to utilize Rule 506(c) would be just as unworkable as the worst of the Commission's previous failed attempts to "help" small businesses form capital more easily, such as via the Commission's non-existent-in-practice Rule 504 "Seed Capital" exemption.
Since the JOBS Act eliminates the broker/dealer from the capital formation equation for early-stage "microcap" companies which raise capital from the public, the Commission has no choice but to impose a minimum Form D and Form ID filing requirement, and to punish offenders aggressively for non-compliance, because these unregistered public Offerings will not even have the potential protections and oversight by broker/dealers in the manner that common sense should have dictated.
If the Commission does wish to create a special exemption for "small businesses" that will guarantee that no "microcap" or "startup company"
issuer will be unfairly burdened by the revised Regulation D filing requirements in a Rule 506(c) Offering, then the Commission should perhaps grant an exemption from Rule 507(b) and Rule 510T and Rule 503 on the condition that the "small business" issuer conducts its Rule
506(c) public Offering exclusively through a licensed broker/dealer.
As the Commission is aware, licensed broker/dealers have typically been unable to assist small businesses with unregistered public Offerings of any kind, prior to the JOBS Act, because of the prohibitions enacted in the 1933 Securities Act and because of the Commission's own past absurd mismanagement of its duty in this regard. It is not yet clear whether licensed broker/dealers will see any way to help with issuers' Rule
506(c) Offerings, without exposing themselves to unpredictable enforcement actions and other potential liability. If broker/dealers do not see a way to help small businesses with Rule 506(c) Offerings, because the Commission does not expressly encourage this activity by broker/dealers with such an exemption, then it will be yet another ridiculous failure of the Commission to regulate using common sense.
Co-Founder and CEO
Public Startup Company, Inc.