Last week Jack Herstein, president of NASAA wrote a comment letter to the SEC on rulemakings under Titles II, III, and IV of the JOBS Act. The comments related to Title II, which authorizes general solicitation under Rule 506 of Regulation D, are particularly interesting since the Title II rules may be implemented as early as August (the rules were supposed to be enacted by July 4, but that was a fairly unrealistic timeline that Congress set).
NASAA’s Suggestions for Title II Rulemaking
NASAA separated its Title II suggestions into four categories: verification requirements, regulation of platforms, filing requirements, and deceptive advertising.
Background: The current 506 regulations require issuers to “reasonably believe” that the investors satisfy the requirements to be an accredited investor. The JOBS Act requires issuers to take “reasonable steps to verify” the investors status as an accredited investor. The SEC is tasked with making rules to determine what will satisfy the verification requirement.
NASAA’s verification requirements suggestions:
- Require the production of evidence to demonstrate the requisite income level or net worth
- Require the issuer to maintain the confidentiality of any information received for the purpose of verifying the investors’ status as accredited
- Require an issuer to retain records for at least five years in order to preserve the proof that its verification efforts were reasonable
- Allow an issuer to obtain the necessary verification through registered broker-dealers, provided there are independent liability provisions for failure to adequately perform the verification… NASAA then suggests: “the broker-dealers could develop registries of accredited investors, leading to an efficient mechanism for issuers to verify whether investors are accredited.”
- Create non-exclusive safe harbors to specify the types of actions that will be deemed “reasonable steps to verify.” The verification requirements should be tailored to three types of accredited investors: (a) natural persons satisfying the income test; (b) natural persons satisfying the net worth test; (c) entities satisfying any of the tests.
For Verification of Natural Person’s Income:
- Tax returns, form W-2′s, and form 1099′s along with recent pay stub should satisfy safe harbor
For Verification of Natural Person’s Net Wealth:
- A simple fill-in-the-blank self-certification should not be sufficient
- Require an issuer or broker-dealer to obtain documentation that the investor has at least $1 million in assets, excluding the primary residence. Documentation could include bank statements, brokerage account statements, tax assessment valuations, or appraisals.
- Additionally, require a list of liabilities from the investor, including a sworn statement that all liabilities are disclosed.
- Alternatively, if an investor makes an investment in excess of $1 million in the issuer’s securities, issuers should be entitled to presume that the investor has a net wealth in excess of $1 million.
For Verification of Entities:
- Organizational documents and simple balance sheets may be sufficient for most entities; quarterly statements could be used for employee benefit plans.
Regulation of Platforms
Background: Title II of the JOBS Act authorizes an intermediary or “platform” to facilitate an offer, sale purchase, or negotiation of securities. These platforms are also allowed to conduct “ancillary services” including due diligence and the provision of standardized offering documents. The platforms are prohibited from transaction-based compensation and custody.
NASAA’s platform regulation suggestions:
- Articulate the scope of ancillary services that are permissible for unregistered platforms
- Establish bright lines between compensation in connection with the purchase or sale of a security and compensation for ancillary services
- Require that the due diligence performed by a platform be no less rigorous than the reasonable investigation required of broker-dealers
Background: Currently, an issuer must file a new Form D with the SEC for each new offering of securities no later than 15 calendar days after the “date of first sale” of securities in the offering. Additionally, under current rules a 506 offering may include up to 35 non-accredited investors. Under Title II of the JOBS Act, 506 offerings exclusively to accredited investors can include general solicitation.
NASAA’s filing requirements suggestions:
- Require issuers wanting to take advantage of general solicitation to file a Form D before the public solicitation begins.
- Change the filing deadline at the same time that the rule is changed to facilitate public solicitation
Rationale for pre-filing requirement:
“Without a strict pre-solicitation filing requirement, unscrupulous promoters will have an easy defense against injunctive actions by state and federal regulators. We will have no way of knowing whether a promoter is legitimately trying to comply with Rule 506, so a fraudulent offering will be allowed to continue until the regulators have gathered sufficient evidence to prove fraud has already occurred. As a result, it will be much more difficult to prevent or stop investor losses.”
- Improve the Form D to require enhanced disclosures (NASAA attached it’s recommended revisions to its comment letter)
Background: Under Title II of the JOBS Act, issuers using a 506 exemption will be enabled to publicly solicit investment for the first time.
NASSA’s suggestions for protections against deceptive advertising:
- Require advertising to comply with requirements that are similar to those applicable to registered offerings.
- Require issuers to include a “balanced presentation of risks and rewards”
- Require that statements in advertising are consistent with representations in the offering documents