Proposed Law to Introduce SEC or State Review of Rule 506 Private Placements is a Disaster

Senator Dodd’s 1328 page bill (Restoring American Financial Stability Act of 2010)  contains a provision under Section 926 entitled “Authority of State Regulators over Regulation D Offerings” that would take away the ability of Start-up companies to raise funds without review by the SEC or state securities regulators.

Currently, companies and private funds that want to raise money may do so from “accredited investors” (people with a net worth of $ 1 million or more) without prior review of the offering by any federal or state regulator if the issuer complies with Regulation D’s Rule 506.  That Rule forbids advertising and public solicitation, but otherwise does not prescribe the form of offering documents or the content of disclosure.  Within 15 days of the first closing, the issuer is required to file a Form D with the SEC and with the securities regulators of the states in which the investors reside.

Rule 506 does not stand in isolation. Other federal and state laws require that a person who sells securities disclose all material facts that impinge on the value of that security. State securities regulators possess numerous civil and criminal remedies to prevent or punish fraud. Injured investors can sue for rescission or damages, statutory interest (at 8% in Washington State) and recovery of attorneys’ fees.

Yet to police potential fraud even earlier in the process, Senator Dodd’ bill proposes to let the SEC decide by rule-making which offerings it would like to review.  Those deals that the SEC does not review would be subject to review by state regulators. (This is a gross over-simplification of what the bill actually says, but it will suffice for today.)

The point is that to try to catch a handful of bad guys (who presumably won’t even file Form Ds if this bill becomes law), all the honest companies out there who want to conduct private placements will need to incur significantly greater costs to comply with securities laws.

The timing of this “reform” effort is unbelievable.  The world economy is just beginning to climb out of a massive recession and bank credit has virtually dried up.  Small and start-up businesses are unable to obtain loans of any kind other than from the Small Business Administration.  Now the one source of funding that has functioned reasonably smoothly in these troubled times, the angel market, is in danger of being tied up in red tape.

We need to let our federal and state governments know that this bill is a disaster. It is time to start howling with rage.

John A. Myer is a corporate and securities lawyer with Myer Law PLLC in Seattle, Washington.   This posting does not constitute legal advice.