All The World’s A Stage, But The SEC Isn’t Allowing All Actors To Play Upon It

by Allen Matkins
Contact

Every Rule Must Play It’s Part, But This Part Is A Sad One

There is much to dislike in the SEC’s recent “bad actor” rule amendments.  While Congress conceived the idea of disqualifying bad actors (Section 926 of the Dodd-Frank Act), the SEC was more than a midwife.  Here are a few reasons why I believe that the SEC’s naughty thespian rule amendments will make the world of Rule 506 offerings a more treacherous place for issuers trying to raise much needed capital:

1.  The list of “bad actors” is long and ambiguous.

The SEC chose to include the categories of persons covered by Rule 262, the rule governing disqualification in Regulation A offerings.  While this can be justified by Section 926's reference to Rule 262, Congress made it clear that the new rule need not match Rule 262 exactly.  Indeed, the SEC’s rule amendments added categories of miscreant performers to those in Rule 262.  If the SEC has authority to add players, there is no reason why it couldn’t remove a few from the stage.  By my count, there are approximately 20 categories of persons who are subject to potential disqualification.  The actual number of persons could be quite large.  Moreover, some categories are ambiguous.  For example, what does it mean to “participate” in the offering?  In the adopting release, the SEC downplayed the difficulty of this determination, but provided no guidance on what participation might include.  Other categories could require extensive analysis.  For example the adopting release states “In particular, the definition [of promoter in Rule 405] requires issuers to look through entities and makes it unnecessary for us to separately cover officers, directors and other control prsons that qualify as promoters.”

2.  The list of disqualifying events is long and complicated.

Again, the SEC looked to Rule 262 in formulating the list of disqualifying events.  While Rule 506 is used by large, sophisticated issuers it will be also used by a great many start-up and small companies.  I’d be surprised that the average founder of a start-up could tell you which provisions of the Securities Act, Securities Exchange Act and Investment Advisers Act are “scienter-based anti-fraud” provisions.

3.  The list of disqualifying events is inconsistent with the disclosures mandated by Item 401 of Regulation S-K.

Reporting companies also rely on Rule 506 (e.g., in Rule 144A transactions).  These companies are subject to disclosure of various bad acts pursuant to Item 401 of Regulation S-K.  The Item 401 disclosures, however, are not the same as the Rule 506 disqualifying events.  While this isn’t entirely illogical, it is inconvenient and adds to the complexity of disclosure in an extremely complex disclosure regime.

4.  The SEC’s use of “facts and circumstances” to determine reasonable care is decidely unhelpful.

From a regulatory perspective, it is useful to provide a very general standard and then state that compliance must be determined on a “facts or circumstances” basis.  This gives maximum flexibility to the regulator while providing no guidance to the person subject to the rule.  I suspect that many people will try to establish reasonable care by the use of questionnaires or certifications, but the SEC has said only that this “may be sufficient in some circumstances”.  Issuers may check on-line databases, but the SEC admits that “there is no central repository that aggregates information from all the federal and state courts and regulatory authorities that would be releveant in determining whetehr covered persons have a disqualifying event in their past.”  Another question will be “how deep should we put in the plow?”  Again, the SEC offers no useful guidance, saying only that “in general” issuers should make factual inquiry of covered persons but that it may be sufficient to make inquiry of an entity concerning the relevant set of covered persons.

5.   The SEC’s burden and cost estimates are unrealistic.

The SEC’s cost estimates that 19,908 Rule 506 issuers will spend on average only one additional hour of time conducting the factual inquiry necessary to establish reasonable care.  Given the size of the list of covered persons and the complexity of disqualifying events, this estimate is wholly unrealistic.

4.  The amendments make Rule 506 very perilous.

The effect of the SEC’s rule amendments is to make Rule 506 unavailable for the sale of a security if any covered person suffers from a disqualifying event.  This disqualification will apply to “traditional” Rule 506 offerings as well as offerings in which there is a permitted ”general solicitation”.  While Rule 506 is a non-exclusive safe harbor, the loss of the exemption means that the issuer also loses preemption of state securities laws under Section 18 of the Securities Act.  This may prove to be particularly problematical for issuers who take advantage of the impending rule changes permitting general solicitations because state exemptions may be conditioned on the absence of a general solicitation (e.g., Cal. Corp. Code § 25102(f)). 

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.

© Allen Matkins | Attorney Advertising

Written by:

Allen Matkins
Contact
more
less

Allen Matkins on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.