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Start-Ups Ask for Withdrawal of Proposed Form D Changes

November 6, 2013

The SEC is planning to increase the amount of information it gathers from companies and fund managers that use the market for private securities offerings. While SEC officials and investors see the proposed changes as a necessary means for limiting the risk of fraud, some businesses fear that the changes will disrupt the still developing market for the limited offerings.

Start-up companies and venture capitalists asked the SEC to withdraw its plan to increase the amount of information it collects on private securities offerings.

The groups say the proposed changes will prevent many small businesses from taking advantage of the eased funding rules the agency adopted in July when it issued the proposed changes.

Investor advocates want the SEC to strengthen the rules to prevent fraud.

The comment period for Release No. 33-9416, Amendments to Regulation D, Form D and Rule 156, closed on November 4, 2013. The comment deadline had been scheduled to end in September but was extended after small businesses asked for extra time.

The proposal would require companies and fund managers to file a Form D for offerings made under Rule 506 of Regulation D of the Securities Act of 1933 15 days before marketing the offering to investors.

The existing version of Regulation D requires a filing within 15 days after the securities have been sold to investors.

The SEC said the filing requirement will help it gauge the effectiveness of the changes in Release No. 33-9415, Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, which was mandated by the JOBS Act.

The loosened restrictions are intended to make it easier for small companies to raise capital and advertise securities offerings to “accredited” investors.

Nine organizations that support start-ups and entrepreneurs, including the Angel Capital Association and National Business Incubation Association, said the changes proposed in Release No. 33-9416 will force entrepreneurs “to navigate a minefield of potential regulatory sanction when making any type of public comment if even contemplating a future offering.”

The groups said requiring entrepreneurs to electronically furnish copies of marketing materials as soon as they’re being shown to the public imposes “fatal burdens of cost and complexity on issuers who can least afford it.”

The groups also had issues with how the SEC lifted the marketing ban on limited offerings in Release No. 33-9415 and asked for guidance.

They said the requirement that companies and funds take “reasonable steps to verify” that investors are accredited shouldn’t include disclosure of personal financial information by angel investors already well-versed in the start-up economy because they are both accredited investors and knowledgeable about the risks of angel investing.

Americans for Financial Reform (AFR), a coalition of more than 250 groups, said the requirements proposed for Form D in Release No. 33-9416 are a small but inadequate step forward to restoring regulatory protections.

AFR criticized “the commission’s total failure to act proactively to prevent a predictable emergence of confusing and misleading advertising practices” particularly by private funds that make performance and fee claims. The group urged the SEC to develop reasonable standards for private fund advertisements that should require performance claims to be based on a recognized performance standard.

AFR said it believes updating the definition of accredited investor is the single most important step the SEC can take to ensure that unregistered securities sold under Rule 506 are sold only to those who are financially sophisticated enough to understand the risks and wealthy enough to absorb losses.

Accredited investors must have a net worth of $1 million excluding the value of their primary residence or a net income of $200,000 in the two most recent years.

The current definition fails to meet the standards, and AFR urged the SEC to look beyond merely increasing the financial thresholds to reflect inflation but to also consider incorporating measures of investment knowledge, experience, and financial sophistication into the definition.

Keith Higgins, director of SEC’s Division of Corporation Finance, recently told the Senate Banking Committee on October 30 that his staff has begun a review of the definition and by mid-July 2014 will complete a study on the issue. The Dodd-Frank Act called for such a study every four years.

The question is how sophistication should be defined.

“I don’t know whether anybody has quite yet found what the answer is,” Higgins said.

Several ideas are being looked into, including the Government Accountability Office’s suggestion of investor education, he said. Investors could be tested, but the tests would be hard to administer.