Smoke, and mirrors
With the stated goal of making it easier for entrepreneurs to access capital, the JOBS Act mandates that the SEC open up general solicitation for certain offerings under Rule 506 of the Securities Act of 1933. The provision was originally supposed to have been implemented swiftly and efficiently, within 90 days of the Act’s signing into law last spring. Instead, that process has dragged on for many months, and remains in limbo as the year winds to a close.
Few SEC rulemaking proposals in recent memory have ignited such a firestorm. Nearly 200 public comments on the rule have been submitted to the Commission. A recent article in the Wall Street Journal even reports that lame duck chairman Mary Schapiro, apparently feeling the heat, has resolved to punt the issue to her successor rather than risk damage to her “legacy.”
An especially incendiary question has been how or whether “accredited investors” – key players here, for only they may purchase securities under the new, looser provision – should be identified, defined, or vetted. On the one hand, those nervous about fraud and abuse would like there to be a litmus test, and preferably a series of hoops to jump through, for anyone claiming to be an accredited investor. On the other hand, those nervous about excessive regulation would prefer to keep things on a kind of honor system basis, governed merely by the rule of caveat emptor. Anna Pinedo of Morrison Foerster references an example of the latter in the MoFo Jumpstarter blog.
An interesting comparison here is how the SEC, implementing another provision of the JOBS Act, has so far handled the Emerging Growth Company (EGC) label. Like “accredited investors,” ECGs are granted special rights and privileges under the Act. Unlike accredited investors, EGCs are clearly defined by rule. However, an important similarity between the two is that there is no set process in place for certifying in advance that an entity qualifies for the special status. In theory, any old company can make the declaration that they’re an EGC and begin making filings accordingly, just as any street hustler could theoretically claim to be “accredited.”
Granted, in the case of a filer’s dubious claim of EGC status, the SEC would presumably intervene, whether through Comment Letter correspondence or (more seriously) through an enforcement action. But such vetting would only occur after the fact. Could an ersatz EGC get so far as to go to market with its fraudulent label still in place? Far-fetched though it may be, this hypothetical situation mirrors in the public market what the pro-regulation camp fears might happen in the private market.