Tuesday, October 11, 2011

Legislation Allowing General Solicitation under SEC Rule 506 of Regulation D Approved by Capital Markets Subcommittee

Legislation removing the general solicitation prohibition in SEC Rule 506 under Regulation D and allowing small businesses to attract capital from accredited investors nationwide and globally, in order to grow their company has been approved by the House Capital Markets Subcommittee. The Access to Capital for Job Creators Act, HR 2940, introduced by Rep. Kevin McCarthy (R-CA), is primarily designed to eliminate the cost burden associated with SEC registration that small businesses face. HR 2940 would require the Commission to revise its rules to permit general solicitation in offerings under Rule 506 of Regulation D. The legislation was approved by voice vote.

There were two amendments to the bill during the mark-up session. The first, introduced by Rep. Maxine Waters (D-CA) mandates that the revised SEC rules allowing a general solicitation under Regulation D must require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors using methods determined by the Commission. The second amendment, introduced by Capital Markets Subcommittee Chair Scott Garrett (R-NJ) amended Section 4(2) of the Securities Act by adding the language whether or not such transactions involve general solicitation or general advertising. Both amendments were approved by voice vote.

Any company looking to sell securities must register with the SEC or meet qualifications under Regulation D in order to be exempt from SEC registration. Regulation D exemptions are designed so that small companies can access capital markets without bearing the costs of SEC registration. Under Rule 506 of Regulation D, certain companies may be exempt from SEC registration if they meet specific conditions, including a prohibition on general solicitation.

The general solicitation prohibition has been interpreted to mean that potential investors must have a pre-existing relationship with an issuer or intermediary before the potential investor can be notified that unregistered securities are available for sale. According to Rep. McCarthy, this ban severely hampers the ability for small companies to obtain needed capital from investors, and as a result, many companies are limited to only to the universe of investors with which they clearly have pre-existing relationships. This legislation would remove the solicitation prohibition and allow small businesses to attract capital from accredited investors nationwide, or even globally, in order to grow their company.

SEC Chairman Schapiro has asked the staff to review the restrictions that SEC rules impose on communications in private offerings, in particular the restrictions on general solicitation, noted Corporation Finance Director Meredith Cross in recent testimony at House hearings on the legislation. Recognizing the increased use of the Internet and other modern communication technologies in private offerings, said the Director, the SEC staff has issued no-action letters providing issuers with flexibility to use modern communication technologies without the staff recommending enforcement action regarding the general solicitation restriction. Notwithstanding these efforts, she observed, the restriction on general solicitation is cited by some as a significant impediment to capital raising.

The SEC understands that some believe that the restriction may be unnecessary because offerees who might be located through a general solicitation but who do not purchase the security, either because they do not qualify under the terms of the exemption or because they choose not to purchase, would not be harmed by the solicitation. In addition, some have questioned the continued practical viability of the restriction in its current form given the presence of the Internet and widespread use of electronic communications. At the same time, others support the restriction on general solicitation on the grounds that it helps prevent securities fraud by, for example, making it more difficult for fraudsters to find potential victims or unscrupulous issuers to condition the market.

Director Cross said that it is important to consider both of these views about the need for the restriction on general solicitation in private offerings when considering possible revisions to SEC rules. In analyzing whether to recommend changes to the restriction, the staff is considering next steps, including a possible concept release for the Commission to seek the public’s input on the advisability and the costs and benefits of retaining or relaxing the restrictions on general solicitation.