As you have undoubtedly heard, the SEC has been criticized for delay in propounding these rules by various investor and industry groups.  The SEC is required by the JOBS Act to provide for an exemption for crowdfunding as well as disqualify those persons barred by a state authority from engaging in the securities business, convicted of a felony or misdemeanor relating to the sale of securities, or making false SEC statements.  To complicate matters, the SEC already has a pending Dodd-Frank Act rule to preclude certain "felons and bad actors" from participating in private offerings pursuant to Regulation D.  This proposed rule included certain events that occurred prior to the enactment of the Dodd-Frank Act.  Interestingly, when questioned about the delay, the SEC’s response was there were a lot of comments on this proposed rule. 

We expect that whenever the SEC finally gets around to approving final rules, the criticism and rancor should be deafening.

The real quandary that the guidance addressed was related to the Elliot Spitzer settlement between regulators and major investment banks announced in 2003.  This settlement required strict firewalls between research and underwriting activities at certain major banks.  The SEC Staff clearly indicated that the JOBS Act “does not change" the settlement, thus requiring said signatories to obtain court approval to alter the pact.  If these signatories sought to change the pact, the SEC would then consider such an application, and respond accordingly.  However, the  SEC's view at this point is that it has no authority to change this settlement with a rule. 

Essentially, the SEC has said nothing has changed with the JOBS Act, and, if investment banks want to take advantage of the JOBS Act provisions, they better be prepared for a Court fight from the SEC.

The JOBS Act required to the SEC to allow Securities Act of 1933 Rule 506 issuers to broadly market their securities so long as the securities were purchased only by accredited investors, and to eliminate the advertising prohibition under Securities Act Rule 144A.  One issue left open by this rule proposal is that there is no specific verification method to determine accredited investor status.  The SEC believes such an approach would not be worthwhile since there are many ways to do so.  Issuers must instead take "reasonable steps" to determine such a status under the proposal.

Although the SEC proposed this rule sometime ago, no action has been taken. 

Ironically, the SEC still has not promulgated rules for allowing small businesses to raise capital online.  The SEC believes that those rules are months away.  Nonetheless, regulators estimate that there are almost 9,000 websites already dedicated to crowd-funding.

Regulators are deeply concerned that the proliferation of these sites could create more trouble for regulators, who are charged with enforcing thse rules and ensuring investor safety.

A quick overview for the uninitiated:  artists, musicians, inventors and entrepreneurs all can use Kickstarter or Indiegogo to raise funds for a specific project: money to make a film, record an album, or bring a new product to market.  These projects are marketed to potential donors using engaging YouTube videos accompanied by written descriptions and a list of potential perks a donor will get based off of how much they give.  Usually, small amounts gets you a thanks and nothing more; larger amounts should get you something tangible (the to-be-recorded album, or the product); and even larger donations means you should get some special perks too (like a signed album, or even a private concert). 

Note how I said "should get"?  That's because Kickstarter, the more famous of the two, has received some less-than-outstanding press lately.  Projects that have raised fantastic amounts - $10 million for a watchmaker, $600 thousand for a lightbulb - have failed to produce the promised products, angering the donors who expected something in return.

Kickstarter policy states that failed projects should refund money, but the website lacks any real mechanism to enforce that. 

Kickstarter has responded: not by creating a claw-back mechanism, but by changing the rules about how a project can be advertised.  In a blog post entitled "Kickstarter is not a store"  Fundraising projects for products and computer hardware now have stricter requirements on what they can say to potential backers.  This is all in an effort to temper expectations amongst these backers, who have unrealistic expectations of success.

Most notably, to me, is the new "Risks and Challenges" requirement, which will force the projects to explain the perils that lie ahead for their vision.  As Felix Salmon notes, bringing a product to market is a difficult process full of all sorts of unexpected pitfalls and problems. 

To me, this sounds a lot like the SEC's requirements on issuers of securities, both public and private.  The SEC requires issuers to explain the risks facing the company.  Public companies have much larger risk disclosure requirements, but even a company making an offering under Reg D has to notify purchasers of the perils involved.

What's next for Kickstarter?  The company clearly is looking to improve its market.  It'll be fascinating to see what other rules they'll place on their "issuers" to make Kickstarter more efficient.   

Crowd funding allows companies to finance new businesses by accepting and pooling donations of up to $1 million over the Internet if certain conditions are met.  However, the SEC has to adopt regulations governing these funding portals before allowing anyone to register with the SEC.  Currently, the SEC has not finished adopting those regulations. 

Accordingly, it is important to keep in mind that those wishing to engage in crowd funding should not engage in such activities until the SEC announces these regulations. 

As a result of this status, the JOBS Act requires these companies to disclose such a status in their public filings with the SEC.  This disclosure and the resulting status has impacted both the accounting and auditing sides of the business, requiring these companies to act accordingly.  The SEC has also issued Frequently Asked Questions guidance to address these requirements and status under the JOBS Act.  Further, the PCAOB will also be limited in requiring mandatory audit rotation for these Emerging Growth Companies.

In short, the JOBS Act is still a work in progress, and it will be interesting to see its long-term applications on the public filings of these Emerging Growth Companies.

First, a quick review: Section 4(a)(2) of the Securities Act of 1933 exempts transactions “not involving any public offering” from the pricey and time-consuming registration requirements of Section 5 of the Securities Act.  Rule 506 was (and still is) a safe harbor under Regulation D under Section 4(a)(2) of the Securities Act, meaning that if an issuer met its requirements, it could safely assume that the offering was not public. 

Among other things, Rule 506 prohibited “general solicitation and general advertising” which is exactly what it sounds like.  In addition, an issuer relying on Rule 506 could sell to an unlimited number of accredited investors (basically: investment companies, funds, and wealthy people) and no more than 35 “sophisticated” non-accredited investors (basically: normal people who arguably have some idea of what an investment is).  A Bizarro Kanye might say, “the SEC doesn’t care about rich people” (that’s not exactly true, but remember: Bizarro isn’t that smart).  After those 35, an issuer had to “reasonably believe” that the investors were accredited.

That was the old Rule 506, hereby known as Rule 506(b).  The new Rule 506, or Rule 506(c), removes the ban on general solicitation, but issuers can only sell to accredited investors – no more 35 sophisticated non-accredited guys.  It also requires that issuers “take reasonable steps to verify” that the investors are accredited.  When the JOBS Act passed, some worried that its mandate to amend Rule 506 meant that the old version would be lost.  We can all rest easy: now issuers have a choice – stick with the stricter advertising rules if you want to offer securities to non-accredited investors, or advertise like crazy and take reasonable steps to verify that everyone you sell to is accredited. 

Rule 506(c) may be a huge benefit to a lot of start ups who have had trouble finding accredited investors to fund their ideas.  If so, this would come at the expense of the “finders” industry, although few entrepreneurs will cry over that side effect. 

The “reasonable steps to verify” also made some fear that Rule 506(c) would lead to mandatory tests or necessary documents to prove accredited-investor status.  There was a concern that issuers would need to undergo much more rigorous due diligence under this new rule.   (These securities professional types are real worry warts.)  Relax: “we [the SEC] anticipate that many practices currently used by issuers in connection with existing Rule 506 offerings would satisfy the verification requirement proposed for offerings pursuant to Rule 506(c).”  The SEC is proposing an objective standard that weighs both the type of information and the amount of information an issuer has about a possible investor.  For example, if that investor claims to be a registered broker-dealer, you could just go to FINRA’s BrokerCheck website to check and be set.  Or if the minimum investment was $1 Million and an investor could provide that (unfinanced) in cash, you could safely assume a personal wealth of over $1 Million (and, also, that he’s a drug kingpin).  The SEC even suggested that a third party verification, such as an affidavit by an investment advisor, accountant or attorney attesting to the investor’s accredited status, would suffice.  That said, the SEC made it clear that simply asking “are you accredited?” ain’t gonna cut it – some due diligence will be required. 

Securities sold pursuant to Rule 506(c) offerings will remain restricted securities.  None of the changes to Rule 506 are meant to imply changes to Section 4(a)(2) or the other rules under Regulation D. 

The SEC is now requesting comments, and has a series of questions that it wants public feedback on.  The majority focus on the verification issue, but I don’t foresee many changes.  The SEC’s proposed approach offers flexibility.  More flexibility also means more uncertainty, but most of that uncertainty will only happen along the margins.  A company performing a decent level of due diligence should be safe.  And, as before, if an investor provides falsified documents and lies convincingly, the issuer will still have reasonable belief and will have taken reasonable steps.  

The SEC also proposed rules to allow general solicitation for Rule 144A re-sales of restricted securities.  This is less interesting, because Rule 144A restricts sales to Qualified Institutional Buyers (QIBS), which are generally investors with over $100 million in assets.  Rule 144A is usually used in initial offerings exempt from registration pursuant to Section 4(a)(2) or Regulation S (a safe harbor for the sale of securities made outside the US).  I’m not sure what this change to Rule 144A is supposed to accomplish, because there isn’t exactly a large target market of QIBS.  If you are planning on making a Rule 144A offering, and your investment banker says something like “well, I don’t know any QIBS, so why don’t we take out a subway ad?” you should fire him. As the SEC said, “Although Rule 144A doe not include an express prohibition against general solicitation, offers of securities under Rule 144A currently must be limited to QIBS, which has the same practical effect.”  That’s diplomatic bureaucrat speak for “we have no clue why Congress made us do this.”

These are just proposed rules, meaning the public has 30 days to comment. 

Further, these advocates are also discussing the definition of the accredited investor standard.  Investor groups are looking to tighten these standards while industry advocates are seeking flexibility.  This dispute has led to the Securities Industry and Financial Markets Association weighing in on the matter, and informing the SEC that it should not impose a higher burden other than the current requirements of Rule 506 and the reasonable belief standard.  Other groups have also asked the SEC to develop a flexible and principles-based standard when it comes to an interpretation. 

Additionally, other disputes have arisen over the question of the JOBS Act's impact on foreign issuers operating in the United States.  Some are suggesting that those companies may or may not be subject to US jurisdiction.  There is no particularized fault line going one way or another at this time as to how that would work.

In short, the JOBS Act continues to be a quagmire with no easy solutions or answers. 

Manchester United – the world’s most valuable sports team, adored by estimated 659 million fans, winner of numerous Premiership titles, FA Cups, and Championship League titles– is going public.  In America.  As an Emerging Growth Company.

And I called it.  Back in May, I said that European companies would increasingly turn to America to do their IPOs, given the EU’s push towards greater shareholder accountability.   Before that, I noted that the definition of an Emerging Growth Company as any company with under $1 billion in revenue meant damn near every company doing an IPO would be an EGC.   

There’s nothing emerging or growing about Man U.  It was founded in 1878.  To grow its fan base, Man U would need to find the lost tribes of the Amazon.  This isn’t even Man U’s first time going public (nothing initial about this IPO) – it was previously listed on the London Stock Exchange until Malcolm Glazer privatized in an leveraged buyout a few years back.  If  Manchester United is an EGC, the JOBS Act needs be amended to rename Emerging Growth Companies as “Pretty Much Anyone Not Already Public In America Company” or PMANAPIAC for short.   

Now, there are more reasons why the devilish denizens of Old Trafford are setting up shop on the NYSE.  In America, unlike Europe, dual-class share structures are perfectly fine and popular with massive companies controlled by its founders (Facebook has a dual-class structure).  Dual-class shares give some shareholders voting preferences over others.  In the Man U deal, the Glazer family will get 10 votes for each of their stocks, whereas the participants in this IPO will get 1 vote per share.  That way, control of the company remains private, despite it being nominally public.  Normally NYSE rules require listed companies to have boards with a majority of independent directors, but that rule is waived for controlled companies, like Man U.

Man U isn’t the only famous, venerable brand that has recently announced its emergence and growth:  Fender, as in the bad-ass guitars, announced its EGC IPO in May.  Keep in mind that Fender's been around longer than the Rolling Stones, yet it's still emerging. 

Finally, to go wonky for a second, the popularity of EGC status, which allows companies to disclose less information for 5 years, proves that the theory that investors will discount based on less disclosure is bumpkis.  Some finance nerds have argued that companies that take advantage of weaker disclosure rules end up hurting their stock price because investors will avoid them.  It’s one of those theories that sounds really good until you remember that the only people who read prospectuses and 10-Ks are the lawyers who drafted them.  For every one investor who will avoid Man U because it’s registration statement will report the last two years of audited financial statements instead of three there will be another dozen who buy Man U because WAYNE ROONEY IS A BEAST.  The dual-share voting structure will deter serious investors, though, who won't like the idea of being unable to toss out management if they don't perform well (management, by the way, means Glazer's two sons).

Personally, I will not be buying stock in Man U.  Not because they are using most of the IPO proceeds to pay down the huge debt from the LBO.  Not because I'll be stuck with Americans running an English football team.  Not even because the soccer labor market pays players unsustainable and ludicrious sums of money.  No.  I won't buy Man U because I'm a gooner.

Mary was not quite contrary here - I don't think anyone expected the SEC to make this deadline (And Ms. Schapiro told Congress that they couldn't do it before the bill passed, but did they listen?).  As I've stated before, the SEC is swamped and this was a very short deadline.  Many of the JOBS Act changes were immediate, so the SEC has been in triage regulation-preparation mode for a few months now. 

More interesting, though, is the reason Chairwoman Schapiro gave for the SEC's delay in adopting new rules.  She specifically mentioned the specific requirement in the eventual rule that it must make sure that issuers take "reasonable steps to verify that purchasers of the securities are accredited investors."  This confirms what we already suspected: this won't be a simple "check the box" test.  I expect that issuers will need to get financial records from potential investors to prove their status as accredited investors; hell, if it weren't illegal to do so, I'd bet take bets on that right now (I've been doing some work with our gaming law group recently).

In the end, this won't be a big deal, though.  Accredited investors will probably just need to hand over their tax returns from the prior year.  So, sit tight if you want to generally solicit your next 506 offering, or comply with the rule in its current form.   

As you might recall, some of the JOBS Act’s reforms were immediate:  already about a dozen Emerging Growth Companies have taken advantage of confidential registration statement review, and the 12(g) shareholder limit for triggering registration is currently 2000, up from 500 (and excluding employees from that count). 

But the others require the SEC to pass rules before they are in effect.  The SEC was given a 90 day deadline to change Rule 506 and Rule 144A of the Securities Act to remove the ban on general solicitation in those transactions.  With 30 days left to go, the SEC has yet to offer proposed rules.  It’s not a question of whether or not this deadline will be met – it won’t – but rather, how late it’ll be.  Keep in mind that the SC has been so late enacting some of Dodd-Frank’s reforms that it is now being sued for violating the law.  I don’t think we’ll see any 506 issuers launching lawsuits anytime soon (seems like a good way of guaranteeing a little more attention from the Division of Enforcement), but there will be some grumbling. 

If anyone will be intrepid/foolish enough to sue the SEC for missing JOBS Act deadlines, I expect it would be the crowdfunding guys.  The SEC was given 270 days to pass the rules necessary to make crowdfunding happen.  I could see a nascent crowdfunder being idealistic and brash enough to attempt to force the SEC’s hand.  Of course, that would seem like a great way of ensuring that the Division of Corporate Finance regulates crowdfunding into the ground.  Given the large amount of public interest, the potential for fraud, and the appeal it might have to retail investors (of whom the SEC is extra protective), expect crowdfunding to arrive extremely fashionably late.

Finally, the JOBS Act neglected to give the SEC a deadline on the changes to Regulation A, which is essentially nothing more than adding a zero (the maximum amount that can be raised using Reg A rises from $5 million to $50 million).  So, y’know, this shouldn’t be that difficult.  Heck, I’ll do it right now.

Old: “The sum of all cash and other consideration to be received for the securities ("aggregate offering price") shall not exceed $5,000,000…”

New: “The sum of all cash and other consideration to be received for the securities ("aggregate offering price") shall not exceed $50,000,000...”

Boom.  I didn’t even break a sweat.  That said, applying Parkinson’s Law (work expands to fill the time available to complete it), I expect Reg A to be the last of the JOBS Act reforms enacted. 

The SEC will keep us on our toes this summer.  I don't blame them for the delays - they're already fairly overworked and understaffed, and the JOBS Act didn't help.  Remember to subscribe to the Securities Compliance Sentinel for updates on the  JOBS Act and all your other esoteric federal securities regulatory needs!  We’re your one-stop shop for dinner party discussion topics… if your dinner party is comprised exclusively of CPAs, lawyers and broker-dealers! (And if that’s the case, you need to go to better dinner parties).

PS and apropos of nothing:  The Transit of Venus is tonight, June 5th, around sun-set.  It only happens every 100 years or so, so don’t miss it (but don’t stare into the sun.)

Regardless of the wisdom of making corporate managers more accountable to shareholders - remember that golden parachutes and aggressively leveraged corporations were (and still are) justified as ways of reducing agency costs, and that diversified shareholders tend to be more risk preferring and short-term focused than managers* – this will be good news for US IPO markets.  The JOBS Act’s “IPO On-Ramp” provisions for Emerging Growth Companies already had some betting on more European IPOs on this side of the pond.  Barnier’s proposals will make some European companies decisions that much easier. 

*It's a f'ing stupid idea.  Just look at Say-on-Pay in the States over the last two years: almost every companies that received "no" votes had one thing in common: terrible performance numbers for the past year.  Say-on-Pay exacerbates short-termerism, and being overly obsessed about today at the expense of tomorrow is no way to run a company.  Hell, it's no way to do anything (other than drink heavily).

So take a look at it.  You won't be disappointed.  Unless you thought that crowdfunding was going to upend the way we think of early stage finance and be a truly awesome paradigm-shifter that changes everything.  Then you'll be really disappointed... like a Penguins fan's level of disappointment. 

And here is one more link for good measure: Power to the Crowd!  The Promise (and Pitfalls) of Crowdfunding!