Saturday, April 20, 2013

House Panel Examines SEC Failure to Meet JOBS Act Rulemaking Deadline, Comm. Walter Says Accredited Investor Definition Is Outdated

At a hearing of the Subcommittee on Oversight and Investigations of the House Financial Services Committee examining the failure of the SEC to meet the statutorily imposed deadline for implementing Title II of the Jumpstart Our Business Startups Act (JOBS) Act, SEC Commissioner Elisse Walter testified that the Commission will move ahead to adopt final regulations implementing Title II as expeditiously as possible. This is a top priority for the SEC, she emphasized. During the hearing, Commissioner Walter said that she favors a revision to the definition of accredited investor to focus more on the amount of money a person already has invested.

Title II of the JOBS Act allows private issuers to market their securities through general solicitations and advertising under exemptions to the registration requirements of the Securities Act. The JOBS Act required the SEC to revise its rules to remove the prohibition against general solicitations and advertising in these exemptions within 90 days of its enactment. The deadline for the SEC to revise Rules 506 and 144A was July 4, 2012. The SEC proposed regulations on August 29, 2012, but has not yet adopted the regulations.

Lifting Ban on General Solicitation. Subcommittee Chair Patrick McHenry (R-NC) noted that Title II lifts the ban on general solicitation and Title II is now the law. Thus, in the Chairman’s view, the SEC has lost its authority to enforce the ban on general solicitation for issuers who abide by Title II, adding that at the very least the enforceability of the ban is now questionable.

Commissioner Walter noted that the SEC received approximately 220 ``quite substantive’’ comment letters on the proposed regulations, which generated a meaningful discussion of the issues. She added that the comments were very beneficial in this rulemaking. Moreover, the Commissioner noted that the comment letters were sharply divided, with some commenters saying that the proposal would facilitate capital formation, while others were concerned that the proposed rules would result in an increase in fraudulent offerings.

A Subcommittee staff memorandum related that, on June 28, 2012, then SEC Chairman Mary Schapiro testified at a hearing before the Committee on Oversight and Government Reform’s Subcommittee on TARP and Financial Services, chaired by Rep. McHenry, that the SEC would miss the July 4, 2012 deadline for implementing Title II, but that the Commissioners would vote on a draft rule during the summer of 2012. Within the SEC, an interim final rule was distributed that would have implemented Title II and permitted companies to use its provisions to raise capital. Rather than holding a vote on the interim final rule, Chairman Schapiro instead recommended that the Commissioners vote on a proposed rule, which was approved on August 29, 2012.

Rep. Stephen Fincher (R-TN), a lead sponsor of the JOBS Act, cautioned that, if all the sections of the Act are not implemented together, the full effect of the Act to create jobs and foster economic growth will not be realized. Rep. Dennis Ross (R-FL) said that the SEC has deviated from clear and unambiguous statutory language. Rep. Ann Wagner (R-MO) noted that the mood of investors and entrepreneurs has gone from excitement to frustration over the delay in implementing the JOBS Act.

Commissioner Walter noted, while the 90-day statutory deadline was clear, the SEC needs good cause to dispense with notice and comment and use an interim final rule process. The SEC must also comply with the Administrative Procedure Act. While noting that it is not inevitable that lifting the ban on general solicitation will lead to fraud, Commissioner Walter emphasized that the SEC has an obligation to address the investor protection issues. She also said that the Commission should also put in place a review program and ascertain if there has been an increase in fraud after the lifting of the general solicitation ban and come back and tell Congress the results of the review program.

Definition of Accredited Investor. Shifting the emphasis of the hearing, Rep. Maxine Waters (D-CA), Ranking Member of the full Financial Services Committee, asked if the SEC intends to redefine the definition of accredited investor. Commissioner Walter said that the definition of accredited investor is outdated and should be redefined. Not only should the numerical standards be changed, testified the Commissioner, the SEC should change the criteria entirely on how to measure sophistication. In her view, the current definition of accredited investor does a poor job of screening out people who are unsophisticated. The definition currently covers people who lack the sophistication to evaluate the investment.

Currently,  the definition of “accredited investor” includes natural persons with an individual net worth, or joint net worth, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person; natural persons with incomes exceeding $200,000 in each of the two most recent years or joint incomes with spouses exceeding $300,000 for those years; or businesses in which all the equity owners are accredited investors.

Rep. Denny Heck (D-WA) asked if a review of the accredited investor definition is currently underway. The Commissioner said that the SEC has started to look at the issues.

In reply to a query from Rep. Heck on how she would change the definition, Commissioner Walter said that, in addition to, or in lieu of, raising the numbers in the definition, a new and different criteria should be employed that would look at the amount a person has already invested, since prior experience in investing would be an good objective indicator of financial sophistication. Borrowing from the Title III crowdfunding provisions of the JOBS Act, the Commissioner said that it might be beneficial to require investors to demonstrate an understanding of basic concepts, showing a degree of financial  knowledge. That element could be imported into the accredited investor definition.

Responding to Rep. Heck’s question on how much of an investment would indicate sophistication, Commissioner Walter said that the amount would have to be relatively high, mentioning, for example, $500,000.