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SEC Issues Rules Implementing Certain Provisions Of The FAST Act

Posted by Securities Attorney Laura Anthony | February 2, 2016 Tags: Fast Act, SEC, The Fast Act

On December 4, 2015, President Obama signed the Fixing America’s Surface Transportation Act (the “FAST Act”) into law, which included many capital markets/securities-related bills. The FAST Act is being dubbed the JOBS Act 2.0 by many industry insiders. The FAST Act has an aggressive rulemaking timetable and some of its provisions became effective immediately upon signing the bill into law on December 4, 2015. Accordingly there has been a steady flow of new SEC guidance, and now implementing rules.

On January 13, 2016, the SEC issued interim final rules memorializing two provisions of the FAST Act. In particular, the SEC revised the instructions to Forms S-1 and F-1 to allow the omission of historical financial information and to allow smaller reporting companies to use forward incorporation by reference to update an effective S-1. This blog summarizes these rules.

On December 10, 2015, the SEC Division of Corporate Finance addressed the FAST Act by making an announcement with guidance and issuing two new Compliance & Disclosure Interpretations (C&DI). My blog on the FAST Act and the first two C&DI on the Act can be read HERE. On December 21, 2015, the SEC issued 4 additional C&DI on the FAST Act. Each of the new C&DI addresses the FAST Act’s impact on Section 12(g) and Section 15(d) of the Exchange Act as related to savings and loan companies. My blog on this guidance can be read HERE.

The Amendments – an Overview

Form S-1 is the general form for the registration of securities under the Securities Act of 1933, as amended (“Securities Act”) and Form F-1 is the corresponding form for foreign private issuers.

Section 71003 of the FAST Act

Section 71003 of the FAST Act allows an emerging growth company (“EGC”) that is filing a registration statement under either Form S-1 or F-1 to omit financial information for historical periods that would otherwise be required to be included, if it reasonably believes the omitted information will not be included in the final effective registration statement used in the offering, and if such final effective registration statement includes all up-to-date financial information that is required as of the offering date. This provision automatically went into effect 30 days after enactment of the FAST Act. As directed by the FAST Act, the SEC has now revised the instructions to Forms S-1 and F-1 to reflect the new law.

The Section 71003 provisions do not allow for the omission of stub period financial statements if that stub period will ultimately be included in a longer stub period or year-end audit before the registration statement goes effective. In a C&DI, the SEC clarified that the FAST Act only allows the exclusion of historical information that will no longer be included in the final effective offering. The C&DI clarifies that “Interim financial information ‘relates’ to both the interim period and to any longer period (either interim or annual) into which it has been or will be included.” For example, an issuer could not omit first-quarter financial information if that first quarter will ultimately be included as part of a second- or third-quarter stub period or year-end audit.

An SEC C&DI has clarified that Section 71003 allows for the exclusion of financial statements for entities other than the issuer if those financial statements will not be included in the final effective registration statement. For example, if the EGC has acquired a business, it may omit that acquired business’ historical financial information as well. In a C&DI, the SEC confirms that: “Section 71003 of the FAST Act is not by its terms limited to financial statements of the issuer. Thus, the issuer could omit financial statements of, for example, an acquired business required by Rule 3-05 of Regulation S-X if the issuer reasonably believes those financial statements will not be required at the time of the offering. This situation could occur when an issuer updates its registration statement to include its 2015 annual financial statements prior to the offering and, after that update, the acquired business has been part of the issuer’s financial statements for a sufficient amount of time to obviate the need for separate financial statements.”

As a reminder, an EGC is defined as an issuer with less than $1 billion in total annual gross revenues during its most recently completed fiscal year. If an issuer qualifies as an EGC on the first day of its fiscal year, it maintains that status until the earliest of the last day of the fiscal year of the issuer during which it has total annual gross revenues of $1 billion or more; the last day of its fiscal year following the fifth anniversary of the first sale of its common equity securities pursuant to an effective registration statement; the date on which the issuer has, during the previous 3-year period, issued more than $1 billion in non-convertible debt; or the date on which the issuer is deemed to be a “large accelerated filer.”

Section 84001 of the FAST Act

Section 84001 of the FAST Act requires the SEC to revise Form S-1 to permit smaller reporting companies to incorporate by reference, into an effective registration statement, any documents filed by the issuer following the effective date of such registration statement. That is, Section 84001 allows forward incorporation by reference. At first, I thought this would be a significant change, as currently smaller reporting companies are specifically prohibited from incorporating by reference and must prepare and file a post-effective amendment to keep a resale “shelf” registration current, which can be expensive. However, the SEC rule release includes eligibility requirements, including a prohibition for use by penny stock issuers, which will greatly limit the use of forward incorporation by reference, significantly reducing the overall impact of this change.

As a reminder, a “smaller reporting company” is defined as an issuer that had a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter or had annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available.

As directed by the FAST Act, the SEC has now revised Item 12 of Form S-1 to reflect the changes and to include eligibility requirements for an issuer to be able to avail itself of the new provisions. That is, there are currently eligibility requirements for an issuer to be able to use historical incorporation by reference in a Form S-1. The new rules do not alter these existing eligibility requirements and rather attach the existing eligibility requirements related to historical incorporation by reference to the ability to be able to utilize the new provisions, allowing forward incorporation by reference.

The instructions to Form S-1 include the eligibility requirements to use historical, and now forward, incorporation by reference and include:

The company must be subject to the reporting requirements of the Exchange Act (not a voluntary filer);

The company must have filed all reports and other materials required by the Exchange Act during the prior 12 months (or such shorter period that such company was reporting);

The company must have filed an annual report for its most recently completed fiscal year;

The company may not currently be, and during the past 3 years neither the company nor any of its predecessors were, (i) a blank check company; (ii) a shell company; (iii) have offered a penny stock;

The company cannot be registering an offering for a business combination transaction; and

The company must make its reports filed under the Exchange Act that are incorporated by reference, available on its website, and include a disclosure of such availability that it will provide such document upon request.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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The SEC Issues Guidance On The FAST Act As It Relates To Savings And Loan Companies

Posted by Securities Attorney Laura Anthony | January 19, 2016 Tags: SEC, The Fast Act

On December 10, 2015, the SEC Division of Corporate Finance addressed the FAST Act by making an announcement with guidance and issuing two new Compliance & Disclosure Interpretations (C&DI). As the FAST Act is a transportation bill that rolled in securities law matters relatively quickly and then was signed into law even quicker, this was the first SEC acknowledgement and guidance on the subject.

My blog on the FAST Act and the first two C&DI on the Act can be read HERE.

On December 21, 2015, the SEC issued 4 additional C&DI on the FAST Act. Each of the new C&DI addresses the FAST Act’s impact on Section 12(g) and Section 15(d) of the Exchange Act.

Section 85001 of the FAST Act amends Section 12(g) and Section 15(d) of the Securities Exchange Act such that savings and loan holding companies are treated similar to banks for purposes of the registration, termination of registration and suspension of reporting obligations under the Exchange Act.

In particular, the FAST Act amends Section 12(g) and Section 15(d) of the Exchange Act as follows:

Savings and loan holding companies, as such term is defined in Section 10 of the Home Owners’ Loan Act, will have a Section 12(g) registration obligation as of any fiscal year-end after December 4, 2015, with respect to a class of equity security held of record by 2,000 or more persons.

The holders of record threshold for Section 12(g) deregistration for savings and loan holding companies has been increased from 300 to 1,200 persons.

The holders of record threshold for the suspension of reporting under Section 15(d) for savings and loan holding companies has been increased from 300 to 1,200 persons.

The new guidance explains the timing of the new provisions. The SEC clarifies:

Under Section 12(g)(1)(B), a savings and loan holding company will have a Section 12(g) registration obligation if, as of any fiscal year-end after December 4, 2015, it has total assets of more than $10 million and a class of equity security held of record by 2,000 or more persons. We consider that the effect of this provision is to eliminate, for savings and loan holding companies, any Section 12(g) registration obligation with respect to a class of equity security as of a fiscal year-end on or before December 4, 2015. Therefore, if a savings and loan holding company has filed an Exchange Act registration statement and the registration statement is not yet effective, then it may withdraw the registration statement. If a savings and loan holding company has registered a class of equity security under Section 12(g), it would need to continue that registration unless it is eligible to deregister under Section 12(g) or current rules.

Similarly as relates to the termination of registration:

If the class of equity security is held of record by less than 1,200 persons, the savings and loan holding company may file a Form 15 to terminate the Section 12(g) registration of that class. Until rule amendments are made to reflect the change to Section 12(g)(4), the savings and loan holding company should include an explanatory note in its Form 15 indicating that it is relying on Exchange Act Section 12(g)(4) to terminate its duty to file reports with respect to that class of equity security.

Pursuant to Section 12(g)(4), the Section 12(g) registration will be terminated 90 days after the savings and loan holding company files a Form 15. Until that date of termination, the savings and loan holding company is required to file all reports required by Exchange Act Sections 13(a), 14 and 16.

Alternatively, a savings and loan holding company could rely on Exchange Act Rule 12g-4, which permits the immediate suspension of Section 13(a) reporting obligations upon filing a Form 15, if it meets the requirements of that rule. Note that Rule 12g-4 has not yet been amended to incorporate the new 1,200 holder deregistration threshold.

Finally, as relates to the suspension of reporting obligations:

In general, the Section 15(d) reporting obligation is suspended if, and for so long as, the issuer has a class of security registered under Section 12. When an issuer terminates Section 12 registration, it must address any Section 15(d) obligation that would apply once the Section 15(d) suspension is lifted.

For the current fiscal year, a savings and loan holding company can suspend its obligation to file reports under Section 15(d) with respect to a class of security that was sold pursuant to a Securities Act registration statement and that was held of record by less than 1,200 persons as of the first day of the current fiscal year. Such suspension would be deemed to have occurred as of the beginning of the fiscal year in accordance with Section 15(d) (as amended by the FAST Act). If, during the current fiscal year, a savings and loan holding company has a registration statement that becomes effective or is updated pursuant to Securities Act Section 10(a)(3), then it will have a Section 15(d) reporting obligation for the current fiscal year.

If a savings and loan holding company with a class of security held of record by less than 1,200 persons as of the first day of the current fiscal year has a registration statement that was updated during the current fiscal year pursuant to Securities Act Section 10(a)(3), but under which no sales have been made during the current fiscal year, the savings and loan holding company may suspend its Section 15(d) reporting obligation consistent with the guidance in Staff Legal Bulletin No. 18 (March 20, 2010) and GlenRose Instruments Inc. (July 16, 2012).

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

Follow me on Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.

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SEC Issues Report On Accredited Investor Definition

Posted by Securities Attorney Laura Anthony | January 12, 2016 Tags: Accedited Investor, accredited investor definition, SEC

On December 18, 2015, the SEC issued a 118-page report on the definition of “Accredited Investor” (the “Report”). The report follows the March 2015 SEC Advisory Committee on Small and Emerging Companies (the “Advisory Committee”) recommendations related to the definition. The SEC is reviewing the definition of “accredited investor” as directed by the Dodd-Frank Act, which requires that the SEC review the definition as relates to “natural persons” every four years to determine if it should be modified or adjusted.

The definition of “accredited investor” has not been comprehensively re-examined by regulators since its adoption in 1982; however, in 2011 the Dodd-Frank Act amended the definition to exclude a person’s primary residence from the net worth test of accreditation.

Although the Report contains detailed discussions on the various aspects of the definition of an accredited investor, the history of the different aspects of the definition, a discussion of different approaches taken in other U.S. regulations and in foreign jurisdictions and an in-depth discussion on the reasoning behind its recommendations, the actual recommendations are only conceptual and broad-based and do not contain specifics. Accordingly, we will need to wait for a future proposed rule release to see what, if any, of the recommendations will be implemented and to what degree. This blog provides a broad summary of the Report.

Background

All offers and sales of securities must either be registered with the SEC under the Securities Act of 1933 (the “Securities Act”) or be subject to an available exemption to registration. The ultimate purpose of registration is to provide investors and potential investors with full and fair disclosure to make an informed investment decision. The SEC does not pass on the merits of a particular deal or business model, only its disclosure. In setting up the registration and exemption requirements, Congress and the SEC recognize that not all investors need public registration protection and not all situations have a practical need for registration – thus the registration exemptions in Sections 3 and 4 of the Securities Act and the rules promulgated thereunder. Exempted offerings carry additional risks in that the level of required investor disclosure is much less than in a registered offering, the SEC does not review the offering documents, and there are no federal ongoing disclosure or reporting requirements.

Regulation D provides the most commonly used transactional exemptions to registration. The SEC notes in its Report that $1.3 trillion was raised under Regulation D in 2014 alone. The definition of “accredited investor” provides the backbone to the Regulation D exemptions and is “intended to encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.”

In addition to investor protection, the SEC also has a mandate to assist businesses with capital formation and the definition of “accredited investor” must walk the line between these goals. An overly restrictive definition will damage the ability of businesses to access private capital, and an overly broad definition would be contrary to the SEC’s investor protection goals.

Qualifying as an accredited investor makes the difference between being able to participate in an exempt offering or not, and the ability for an issuer to rely on an exemption or not, and accordingly is a very important component of the securities regulations. For example, some exemptions like Rule 506(c) are limited to accredited investors only. Rules 505 and 506(b) limit offers and sales to no more than 35 unaccredited investors. Many state law exemptions limit offers and sales of securities based on the status of an investor as accredited or not.

An issuer’s required disclosure is also tied into whether investors and potential investors are accredited. For example, under Rules 505 and 506(b) issuers must provide certain delineated financial and non-financial disclosures if an offering will be made to any non-accredited investors.

The Current Definition of “Accredited Investor”

An “Accredited investor” is defined as any person who comes within any of the following categories:

Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act, whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;

Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;

Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;

Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;

Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his or her purchase exceeds $1,000,000, not including their principal residence;

Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;

Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in Rule 506(b)(2)(ii); and

Any entity in which all of the equity owners are accredited investors.

The SEC Report contains an interesting table comparing the regulatory approach to determining the status of investors that are not in need of certain investor protections. I’m reproducing the entire table as appears in the Report:

Standard	Financial Threshold for Natural Persons	Regulatory Purpose
Accredited Investor(Securities Act Rule 501(a))	$200,000 in income$300,000 in joint income $1 million in net worth, excluding the value of a primary residence	Exemption from Securities Act registration for offers and sales to accredited investors
Qualified Client(Advisers Act Rule 205-3)	$1 million in assets under management with an investment adviser$2 million in net worth, excluding the value of a primary residence Subject to inflation adjustment every 5 years	Exemption from Advisers Act’s prohibition on charging performance fees to clients
Qualified Purchaser(Investment Company Act Section 2(a)(51)(A))	$5 million in investments	Exemption from Investment Company Act registration for sales to qualified purchasers
Qualified Investor(Exchange Act Section 3(a)(54))	$10 million in asset-backed securities and loan participations$25 million in other investments	Exemption from broker-dealer registration for banks that sell certain securities to qualified investors
Eligible Contract Participant(Commodity Exchange Act Section 1a(18))	$10 million in investments$5 million in investments if hedging	Eligible contract participants are able to engage in certain derivatives and swaps transactions

The SEC Report discusses the different approaches and their respective histories. The Report also considers the approach taken by different countries including Australia, Canada, the EU, Israel, Singapore and the United Kingdom. The SEC considered these different approaches in making its recommendations. Although a synopsis of these discussions is beyond the scope of this blog, it does provide for interesting reading and insight into the regulatory regime.

SEC Recommendations Related to the Accredited Investor Definition

The Report considered numerous different approaches and potential changes and contains discussion supporting each element in determining an accredited investor and the recommended changes. The Report discusses the numerous different proposals considered, the input of commenters, the challenges that will be associated with each of its recommendations and the reasoning behind such recommendations. However, notably absent from the Report are specific recommendations associated with the broad concepts.

The SEC staff recommends a complete revision to the definition of accredited investor and in particular makes the following recommendations:

Leave the current income and net worth thresholds in place, subject to investment limitations;

Create new, additional inflation-adjusted income and net worth thresholds that are not subject to investment limitations;

Index all financial thresholds for inflation on a going-forward basis;

Permit spousal equivalents to pool their finances for purposes of qualifying as accredited investors;

Add a new qualification for individuals based on measures of sophistication including parameters considering the person’s (i) amount of investments; (ii) professional credentials; (iii) experience investing in exempt offerings; and (iv) status as a knowledgeable employee of a private fund for investments in the employer’s fund. In addition, the SEC recommends permitting individuals who pass an accredited investor examination to qualify as an accredited investor.

Revise the definition as it applies to entities by replacing the $5 million assets test with a $5 million investments test and including all entities rather than the specifically enumerated types of entities; and

Grandfather issuers’ existing investors that are accredited investors under the current definition with respect to future offerings of their securities.

I agree with each of the proposed conceptual changes and in particular the addition of the sophistication qualifications; however, until actual proposals are made that include specifics, such as the specific investment limitations, specific criteria to establish sophistication and specific proposed adjustments, I remain as unspecific in my opinion as the SEC is in its recommendations!

Leaving a strict bright line financial test, without the additional sophistication test, is too restrictive to meet the goal of assisting businesses in accessing capital. According to the SEC Report, in 2013, only 10.1% of U.S. households qualified as accredited investors and adjusting the financial tests for inflation will drop that percent to 3.6%.

The SEC staff points out that there is currently no definition of the term “income” and very limited guidance on the matter. The recommendations do not offer further guidance or suggest any changes. From a practitioner’s perspective, we generally go by the individual’s tax return.

The SEC Report also discussed the net worth calculation. The only asset excluded from the calculation is the person’s primary residence. Many commenters have suggested changes such as the exclusion of retirement assets. The SEC rightfully points out the numerous problems with this approach including, but certainly not limited to, the obvious impact of discouraging retirement investments or encouraging the withdrawal of retirement funds to participate in private investments. Moreover, the Advisory Committee previously pointed out, and the SEC Report acknowledges, that “retirement assets” refer to a tax treatment and not a class of assets, and can be anything from an IRA to racehorses, to bitcoins, to real estate and anything in between. Retirement assets are not classified based on risk and are not somehow risk-protected. Many of the most experienced, wealthiest investors have the majority of their portfolio in assets that receive “retirement assets” tax treatment, and there is no justification for excluding tax-protected accounts from the accredited definition.

I also like the reasoning behind adding investment limitations at certain thresholds and removing them at higher thresholds. Currently the income and net worth tests are absolute. An investor with a $999,999 net worth cannot invest and an investor with a $1,000,000 can invest an unlimited amount. Permitting all individuals that with a level of financial sophistication to be deemed accredited and invest in private offering subject to caps based on net worth or income, will greatly expand the pool of potential investors and be consistent with the need to protect investors.

The SEC Reports suggests a few methods of implementing investment limitations but does not make a specific, precise proposal. The SEC Report suggests examples of limitations such as: (i) an even percentage application across all investors (this approach is rejected); (ii) a gradual increase in investment limitation which limitation is eventually eliminated based on net worth and/or income; and (iii) either separately or in conjunction with other limitations, adding a per issuer limitation.

The SEC Staff recommendations in the Report are consistent with the Advisory Committee’s recommendations made to the SEC in March 2015. In particular, the Advisory Committee made four recommendations related to the definition of “accredited investor”:

(1) That if any change is made to the definition of “accredited investor,” such change should “have the effect of expanding, not contracting, the pool of accredited investors.” For example, they recommended that the definition include investors that satisfy a sophistication test that is not tied to income or net worth. In addition, the Advisory Committee recommended that that tax treatment of assets be excluded from any net worth calculation.

(2) That the SEC take into account the effect of inflation and adjust the accredited investor thresholds in accordance with the consumer price index.

(3) “Rather than attempting to protect investors by raising the accredited investor thresholds or excluding certain asset classes from the calculation to determine accredited investor… the Commission should focus on enhanced enforcement efforts and increased investor education” and

(4) The SEC should continue to gather data on the subject.

Additional History and Further Background

The vast majority of the SEC’s 118-page report provides a history of the Securities Act registration and exemption provisions and the role of the accredited investor definition. The SEC provides the background of the Section 4(a)(2) exemption and a summary of SEC vs. Ralston Purina Co., the leading Supreme Court case interpreting the provision. I’ve previously covered some of this history in my blogs HERE and HERE (written prior to renumbering 4(2) to 4(a)(2)). The following blog HERE on obstacles in depositing penny stocks also provides insight into the exemptions and investor qualifications and as such is beneficial ancillary reading with this blog.

The Advisory Committee Letter to the SEC in March 2015 contained a list of practical facts and realities related to small business and emerging company capital formation in support of its recommendations that I found informative and so am re-publishing. In particular:

Smaller and emerging companies are “critical to the economic well-being of the United States,” generating the majority of net new jobs in the last five years and continuing to add more jobs;

Rule 506 of Regulation D is the most widely used private offering exemption, resulting in $1 trillion of raised capital in 2013;

Most early-stage, venture capital and angel investments are made in reliance on Rule 506;

Other than Rule 506(b), which allows up to 35 unaccredited investors (when certain disclosures and financial information are provided), all investors in Rule 506 offerings must be accredited;

The Dodd-Frank Act requires the SEC to review the accredited investor definition to determine whether it “should be adjusted or modified for the protection of investors, in the public interest, and in light of the economy”;

There are groups and commentators that advocate increasing the thresholds in the accredited investor definition to prevent fraud against investors. However, the SEC is not of “any substantial evidence suggesting that the current definition of accredited investor has contributed to the ability of fraudsters to commit fraud or has resulted in greater exposure for potential victims.” In addition, “the connection between fraud and the current accredited investor thresholds seems tenuous at best”;

Some groups and commentators advocate excluding “retirement assets” from the calculation of net worth. The Advisory Committee rightfully and logically points out that “retirement assets” refer to a tax treatment and not a class of assets, and can be anything from an IRA to racehorses, to bitcoins, to real estate and anything in between. Retirement assets are not classified based on risk and are not somehow risk-protected. Many of the most experienced, wealthiest investors have the majority of their portfolio in assets that receive “retirement assets” tax treatment, and there is no justification for excluding tax-protected accounts from the accredited definition; and

There is little or no evidence to suggest that the existing definition of accredited investor has led to widespread fraud or other harm to investors; rather, there is substantial evidence that the current definition works.

The Advisory Committee concluded that if the income and net worth thresholds are increased, it “will materially decrease the pool of capital available for smaller businesses.” It continued by stating that such a change “would have a disparate impact on those areas having a lower cost of living, which areas often coincide with regions of lower venture capital activity.”

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

Follow me on Facebook, LinkedIn, YouTube, Google+, Pinterest and Twitter.

Download our mobile app at iTunes.

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