Let's Have General Solicitation As Congress Intended It

Editor's note: William Carleton practices law in Seattle, blogs daily at Counselor @ Law and writes a weekly column on implementation of the JOBS Act for VC Experts. Follow him on Twitter at @wac6. 

Everyone passionate about the startup company funding ecosystem was overjoyed by the news last week that general solicitation would soon be okay for startups looking for angel investors.

With one fell stroke, the artificial networking inefficiency imposed by the ban on public communication would be gone. Entrepreneurs and accredited investors would be able to talk freely. Startups would have no impediments to tweeting, blogging, taking out Facebook ads, or engaging in any other kind of social media (or old media) to optimize both the chance to get funded and the chance to fully and expeditiously fill out financing rounds.

Nothing else about angel investing was supposed to change, other than the fact that startups would have to take "reasonable steps" to verify that their investors actually were bona fide angels, before closing the sale.

Fred Wilson wrote the following on his blog about the the SEC's final rules on lifting the ban on general solicitation in offerings limited to accredited investors, now to be known as Rule 506(c):

What this means is that folks raising capital can now advertise the fact that they are doing so. I have been involved in raising close to ten venture capital funds and every time we do that, we have to be quiet about what we are doing until we've done it. That won't be the case anymore.

But there's a problem. And it's not just that general solicitation doesn't actually go into effect until sometime in September (see this great piece from Joe Wallin in the WSJ Accelerators, Time to Advertise Your Private Offering? Not So Fast). Though it wasn't noticed, the SEC on the same day proposed for comment a separate set of rules that, if adopted, could undermine the general solicitation rule it had just voted to approve.

The effect would be to turn general solicitation of angel investors into a minefield filled with bouncing grenades.

This separate set of proposed rules introduces wholly new, wholly un-mandated concepts to Reg D, with new requirements, new filings, new deadlines and new penalties. The effect would be to turn general solicitation of angel investors into a minefield filled with bouncing grenades.

It's as if the regulators thought they were implementing rules under Title III of the JOBS Act, pertaining to crowdfunding for unaccredited investors. But the Congressional mandate to make angel investing easier came instead under the angel financing section of the JOBS Act, Title II, which imposed no new information or filing requirements.

To be sure, Congress was concerned that permitting angel deals to be advertised might lead to hype. If startups went "tweeting for investors," might that not tend to tempt unaccredited investors to shave the truth and misrepresent themselves as angels? To mitigate that risk, Congress instructed the SEC to come up with rules for startups to "verify" that all purchasers in an advertised deal are accredited.

But Congress never meant 506(c) angel deals to be subject to information requirements or the other complexities of crowdfunding regulation. You don't have to read the JOBS Act in detail to appreciate this. Just glance at Title II (about a page) and then skim Title III (nine pages).

Probably the most onerous change proposed is a pre-filing requirement for Rule 506(c) offerings. That proposed rule requires startups to make a publicly available filing with the SEC 15 days in advance of any general solicitation or general advertising. If enacted as proposed, the new filing requirement would take Rule 506(c) deals — and particularly seed financings — out of the natural flow of discussion and negotiation between entrepreneur and angel. If the proposed rules take effect, startups — the best ones — will likely stick with 506(b), which has no pre-filing requirement.

And what of the proposal that startups "submit to the Commission any written communication that constitutes a general solicitation or general advertising in any offering conducted in reliance on § 230.506(c) no later than the date of first use." Does that mean every tweet?

This one-year "penalty box" feature certainly wasn't proposed by Congress.

Another onerous proposed change is one that would apply both to 506(b) and 506(c) deals: a one-year prohibition on using Rule 506 at all if you are late on filing a Form D, or late on amending a Form D, or late on filing a terminating amendment to close out a Rule 506 offering. This one-year "penalty box" feature certainly wasn't proposed by Congress.
Congress should step in and say, "stick with the balance Congress has already struck; we meant to decrease friction in angel investing, not increase it."

The startup community needs to rally and oppose these misguidedly proposed rules. Sure enough, the final rules establishing Rule 506(c) are already here and general solicitation in angel investing will soon be the law of the land, but the SEC's proposed new Reg D rules and filing requirements, if adopted, will make general solicitation more of a burden than an efficiency.