October 4, 2012
1. The Securities and Exchange Commission Should Revise the Rules Retroactively so As to Comply With Congress' Command that the Commission Take Action Within 90 Days.
Section 201(a)(1) of the Jumpstart Our Business Startups (JOBS) Act, the United States Congress specifically directed the Commission to revise its rules within 90 days of the enactment of the Act (i.e., April 5, 2012). The Securities and Exchange Commission has knowingly violated the law by failing to take timely action. Because it is now too late for the Commission to comply, it should at revise these rules retroactively to no later than the statutory deadline.
As pointed out by Justice Antonin Scalia, retroactivity can be an appropriate means for giving effect to Congressional intent when an agency misses a statutory deadline: "If, for example, a statute prescribes a deadline by which particular rules must be in effect, and if the agency misses that deadline, the statute may be interpreted to authorize a reasonable retroactive rule despite the limitation of the APA Administrative Procedure Act." Bowen v. Georgetown Univ. Hospital, 488 U.S. 204, 25 (1988)(concurring opinion). Following Bowen, the D.C. Circuit Court of Appeals has treated Justice Scalia's concurring opinion as substantially authoritative . . . . Nat'l Petrochemical Refiners Ass'n v. EPA, 630 F.3d 145, 163 (2010).
Failure to revise Rule 506 retroactively would be both arbitrary and capricious in light of Congress' express deadline.
2. Eliminating the Ban on General Solicitation Will Yield Numerous Benefits.
In the proposing release, the Commission asked whether there are additional benefits associated with the elimination of the ban on general solicitation. I believe that elimination of the ban will provide the following benefits:
(a) Eliminating the ban will improve access to capital for minority and women owned businesses. Minority and women owned businesses that are not part of the "old boys' club" may not enjoy easy access to capital sources and therefore face greater obstacles in obtaining capital. The ability to engage in a general solicitation will put minority and women owned businesses on a more equal footing with companies that may be better connected to possible sources of capital.
(b) Issuers will face less pressure to use unlicensed finders. Issuers which do not have preexisting relationships with prospective investors are likely to utilize the services of a finder. For a fee, finders will make their contacts available to issuers. In other words, "if you don't know them, buy them". In many instances, however, finders are not registered as brokers. The use of unregistered brokers or finders is more likely in a small offering since registered brokers are likely to find that it is uneconomical for them to act as underwriters or placement agents in small offerings. While the use of an unregistered finder may be permissible in limited circumstances, it presents a variety of risks to the issuer. If it is subsequently determined that the finder should have been registered, the issuer may be subject to regulatory action and the purchasers may have a right of rescission. The ability to engage in a general solicitation will reduce the incentive for issuers to use unregistered finders by making it possible for these issuers to solicit investors directly.
(c) Small businesses will be at less of a bargaining disadvantage vis--vis accredited investors. Although federal and state securities laws are focused on investor protection, small businesses often lack both sophistication and bargaining position in dealing with accredited investors that by definition must be wealthy or sophisticated. For example, many small businesses receive funding from venture capital companies that are professional investors with substantially greater net worths than the companies in which they invest. A small business that is prohibited from engaging in a general solicitation is necessarily limited in its ability to establish a competitive buyers market. Thus, they can be faced with "take it or leave it" situations in which they have no legal method of finding alternative buyers. Elimination of the general solicitation ban will reduce the monopsony conditions that many issuers confront.
(d) Permitting general solicitations will reduce investor risk by increasing public exposure of information to the market. The federal securities laws are premised on a disclosure philosophy. It is therefore ironic that the prohibition on general solicitation has existed at complete odds with this fundamental principle. Rather than encouraging disclosure, it has discouraged it.
(e) Affinity fraud will be diminished. Although Regulation D does not explicitly require that investors have a preexisting relationship with the issuer, the staff of the Commission has considered the existence of such a relationship as a significant factor in determining whether a general solicitation has occurred. This requirement has encouraged offers and sales to persons known to the issuer. Unfortunately, this has had the unintended consequence of directing sales to persons who may be more trusting because of their relationship to the issuer. Indeed, persons are likely to be less trusting of persons they don't know than those they do. The ability to engage in a general solicitation will likely reduce the risk to all investors by making the offering subject to more extensive examination by the market.
3. The Commission Should Eliminate Form D.
The Commission adopted Form D in 1982 for the purpose of eliciting "information necessary in assessing the effectiveness of Regulation D as a capital raising device for small businesses. Release No. 33-6339 (Aug. 7, 1981) 46 FR 41791, 41799. The Commission has now more than three decades of experience with Regulation D. The Commission has never quantified the value of this massive data collection effort. In the meantime, the Commission has amended and expanded Form D. These amendments have increased the regulatory burden on small businesses. The Commission has failed in its Initial Regulatory Flexibility Analysis to consider the alternative of eliminating or significantly reducing the scope of Form D. See 5 U.S.C. Sec. 603(c).
By way of background, I previously served as Commissioner of Corporations for the State of California and as a member of the California Senate Commission on Corporate Governance, Shareholder Rights and Securities Transactions. I have also served as Deputy Secretary and General Counsel to the California Business, Transportation Housing Agency and Interim Savings and Loan Commissioner. More recently, I have served as Co-Chairman of the Corporations Committee of the Business Law Section of the California State Bar. I have also served as an Adjunct Professor of Law at the University of California, Irvine and Chapman University School of Law. I am writing, however, in my individual capacity and not on behalf of my law firm, its clients, or the any of the foregoing.