no Internet to speak of the last time SEC regulations were updated, says Dan Rosen, chairman of the Alliance of Angels and a prior chair of ACA’s public policy committee.
“While before the Internet, it was virtually impossible to get information about companies like these, once the Internet was out there, information was very easy to find,” he says.
The status quo regulations required an investor to have a pre-existing, substantive relationship with an entrepreneur or company in order to invest in unregistered securities, in what is called a quiet offering, because it’s not advertised to the general public. (That relationship can be established by sending investors a questionnaire to ascertain their sophistication and accredited status, provided that the relationship is established some time before the offer to invest.)
“There was a feeling that with a lot of the trends in society on social networks and the Internet that that no longer made sense,” Rosen says.
Allowing companies to generally solicit their offerings gives angel investors access to deals they might not have known about otherwise, and broadens the pool of potential sources of capital for the companies.
Lawmakers concerned about potential fraud at the last minute added a requirement that companies take “reasonable steps to verify” that investors in their generally solicited stock offerings are accredited. It was previously sufficient to obtain a signed form from the investor stating he or she was accredited. That’s still the case for the so-called quiet offerings, which are used much more frequently than the generally solicited ones.
The SEC interpreted “reasonable steps” to mean companies must do things like collecting and retaining investor tax returns. Some businesses and law firms have sprung up to aid in the process, but it remains cumbersome, costly, and off-putting.
“You might as well call it full-employment-for-lawyers act,” Rosen says. “We fought this very hard.”
The EAG Certification was developed as a way to shift the burden of verifying accredited investor status away from the companies and back to the investors themselves, at least in the case of organized angel investing groups.
“The problem is there’s still a lot of uncertainty about taking in money from strangers,” Rosen says. “I think this is an important step in the right direction.”
There remains a need for more clarity in other startup fundraising scenarios—accelerator demo days, for example—where companies have become wary of accidentally generally soliciting their offering, thereby triggering the verification requirement.
“There is a bill pending to basically exempt demo days from the general solicitation definition,” says Gary Kocher, a partner at K&L Gates who focuses on emerging growth companies and venture capital, and serves as outside counsel to the Alliance of Angels.
Higgins, in his speech to the ACA last March, said the advent of Rule 506(c) “may have caused some to focus on the definition of general solicitation itself and wonder, perhaps for the first time, if a particular longstanding practice may in fact be a general solicitation. Some may even be under the erroneous impression that the [SEC] has broadened the definition so that activities such as ‘venture fairs’ and ‘demo days’ are now prohibited. The truth of the matter is that the recent rulemaking has not changed any notions of what constitutes a general solicitation.” But he also acknowledged the uncertainty: “In a funny way, it was probably easier when general solicitation was simply impermissible in all instances.”
Another major issue being watched closely by angel investors is the mandate—imposed by the 2010 Dodd-Frank Act—that the SEC evaluate and update the definition of accredited investor. Raising the net worth and income thresholds would obviously exclude more people. Higgins said the SEC has explored using other criteria, such as stock ownership or professional certifications in relevant investing and financial fields.
“It’s become a very partisan issue,” Kocher says. “But the SEC has to take some action on it, so I think we will see some more activity on that in the course of the year.”
