More New Rules for Startups to Follow

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The SEC has proposed draft rules to implement Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Section 926 of the Dodd-Frank bill required the SEC to adopt rules that disqualify securities offerings involving certain “felons and other ‘bad actors’” from reliance on the safe harbor from Securities Act registration provided by Rule 506 of Regulation D.

These new rules are going to make life more difficult for startups raising capital. Why?

Because now startups are going to have to investigate “covered persons” to determine whether they are “bad actors.” These inquiries are going to take time, and require companies to take affirmative action—a burden that doesn’t exist under the current law.

It sounds innocuous enough, and well meaning—shouldn’t we prohibit startups with “bad actors” involved from accessing the Rule 506 securities law exemption?

Of course we should, you say. That makes all the sense in the world—bad actors are, well, bad!

The trouble is that what if a startup doesn’t realize that one of the “covered person(s)” is a “bad actor.” What if it doesn’t interrogate its new 15% stockholder to discover whether that person has been convicted of a crime (including a misdemeanor) in connection with the purchase or sale of any security?

Well then, the startup wouldn’t have a securities law exemption for its offering and its directors and officers could potentially be exposed to personal liability.

So, the new rules sound good, at first blush, but make no mistake–they make life more difficult for startups.

The new rules still allow startups to access Rule 506 even if turns out that there is a violation of the new rules if the startup “establishes that it did not know, and in the exercise of reasonable care could not have known, that a disqualification existed under paragraph (c)(1) of this section.”

Please see full article below for more information.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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