Month: September 2012

506(c) and General Solicitation and Advertising in Securities Offerings

Section 201(a)(1) of the Jumpstart Our Business Startups Act (the “JOBS Act”) directs the Securities and Exchange Commission to amend Rule 506 of Regulation D. Congress wants to permit general solicitation or general advertising in offerings made under Rule 506, provided that all purchasers of the securities are accredited investors. With one caveat: the issuer must take reasonable steps to verify that purchasers of the securities are accredited investors. After some delays, the SEC has finally published a proposed rule to implement the Congressional mandate.

After waiting all summer for a proposed rule, the SEC decided to finally take action during my vacation. And on the day I promised to take my kids to Story Land. My review of the rule and commentary would have to wait until my kids had their fill of Cinderella and the Bamboo Chutes.

Thanks to William Carleton’s live blog and a review of speeches, I could see that the five commissioners were not in full agreement about the rule or the procedure for adopting the rule. Commissioner Gallagher was in favor of the proposed rules, but wanted it to be an interim final rule. Commissioner Aguilar thought the proposed rules did not go far enough in protecting investors. In the end, that may not mean much.

As expected, the removal of the general solicitation and public offering prohibitions, comes with a few caveats.

Does Not Remove Ban

I found it interesting that the SEC chose to create a new regulatory scheme, rather than merely eliminate the ban. The proposed rule includes a new Rule 506(c) that permits general solicitation and advertising provided all investors are accredited and the issuer takes reasonable steps to verify that they are accredited. 506(b) stays in place allowing an issuer to have up to 35 sophisticated, but non-accredited investors, provided there is not general solicitation or advertising, but does not have to take reasonable steps to verify the investors’ status.

“Take reasonable steps to verify”

The SEC did not do what many feared would be the worst result under the JOBS Act. The proposed rule does not impose any specific requirement to verify that an investor meets the standard of an accredited investor. “Whether the steps taken are “reasonable” would be an objective determination, based on the particular facts and circumstances of each transaction.”

To some extent that seems okay. In the private equity fund model we have a particular concern that a potential investor will be able meet a capital call. It should just mean having to document the diligence process.

However, the SEC did strike one common aspect of fundraising practice.

[W]e do not believe that an issuer would have taken reasonable steps to verify accredited investor status if it required only that a person check a box in a questionnaire or sign a form, absent other information about the purchaser indicating accredited investor status.

Offering documents will need to be changed.

A Non-Accredited Investor Sneaks In

The language of the JOBS Act made some, including me, nervous that if a non-accredited investor could sneak into an offering and blow up the exemption. A person of limited means really wanted to be an investor, lied on the questionnaire, but passed through the reasonable steps taken by the issuer to verify status. Fortunately, the SEC took that position that the issuer would not lose the ability to rely on the Rule 506(c) exemption, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor.

Changes to Form D

In addition, to the new 506(c) the SEC is proposing to amend Form D. The notice filing with the SEC would have a check box to indicate whether an offering is being conducted pursuant to the proposed Rule 506(c) that would permit general solicitation.

Blessing for Private Funds

Private funds typically rely on the Rule 506 safe harbor to raise funds without having to register under the Securities Act. Private funds were also restricted under Section 3(c)(1) and Section 3(c)(7) of the Investment Company Act from making a public offering of securities. Historically, the SEC has considered rule 506 transactions to be non-public offerings. But would the SEC change that position given its hostility towards the JOBS Act?

Thankfully, the answer is no.

We believe the effect of Section 201(b) is to permit privately offered funds to make a general solicitation under amended Rule 506 without losing either of the exclusions under the Investment Company Act.

Comments

Now there is 30 comment period. I’m just guessing, but I’d be surprised to see changes to the proposed rule. I think the benefit of the comment period will be to add some additional commentary around the “reasonable steps to verify” standard.

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FBI and FCPA

In addition to learning about the FBI’s compliance program, understanding white collar criminals, and a visit to the FBI Academy, the FBI Corporate Compliance Officer Outreach Event included a very frank discussion of the Foreign Corrupt Practices Act. The program brought in attorneys from the Department of Justice to discuss their approach to bringing FCPA cases.

Anyone who has read the FCPA Opinion releases may be surprised to hear the practical approach spoken by the presenters. The opinion releases paint a vary minimal threshold for ordinary business entertainment expenses to not be outside the boundaries of a bribe.

The presenters started off with four types of payments that are not bribes:

  1. Facilitation payments (still suspect)
  2. reasonable and bona fide gifts and entertainment
  3. duress payments, when there is a threat of physical harm
  4. Extortion

They pointed out that the key to a bribery case is the corrupt intent. They painted a picture that the DOJ has a hard time finding proof of corrupt intent and an even harder time convincing a jury that there was corrupt intent. In my view, that leaves a lot of grey areas between the de minimis standard in the opinion releases and the much larger payments in prosecuted cases.

They pointed to the Morgan Stanley case as one where the firm’s compliance program stopped the DOJ from seeking further prosecution. As to the compliance defense and credits under the sentencing guidelines for effective compliance programs, the speakers admitted that you rarely see those in cases. However, that is because the DOJ rarely brings cases when they see an effective compliance program.

The last piece of news was to be on the lookout for some substantial guidance on the FCPA. The guidance is not coming out  as a response to the Chamber of Commerce or other critics of the FCPA. It’s a response to the OECD’s review of the US corruption laws in 2010. The Phase III report recommended consolidation and summarization of available information on the application of the FCPA. This guidance will be that consolidation. To meet the deadline of the OECD report, we should expect the guidance to come out in October.

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Marathon Times, Lies, and Paul Ryan

I generally stay away from politics when it comes to any stories about compliance and ethics. Politicians spend too much time spinning the facts and bending the truth. When it comes to policy, the facts rarely tell a black and white story about whether the policy worked, so I can forgive most of the spin. But sometimes the facts are clear and you have to wonder what is going through a person’s mind when they tell a blatant lie.

In an interview with Hugh Hewitt, vice presidential candidate Paul Ryan claimed that he had run a marathon in under three hours.  An impressive time. Unfortunately, that claim was revealed to be untrue. It actually took him more than four hours to finish Duluth’s Grandma’s Marathon.

I ran one marathon. It was ten years ago, but I still remember what my finishing time was. My wife remembers what my finishing time was, because my months of training were so arduous and time-consuming.  Anyone who has run a marathon knows there is a huge difference between running a 3 hour marathon and a 4 hour marathon. A sub-three hour marathon means that you are an elite runner. A four hour marathon means that you are a fit, but still recreational, runner. You spill a great deal of blood, sweat, and tears training for a marathon. Your mileage splits and likely finishing times are burned into your mind during the months of training that lead up to the race itself.

Here’s the transcript of what Ryan said to Hewitt:

H. H.: Are you still running?
P. R.: Yeah, I hurt a disc in my back, so I don’t run marathons anymore. I just run ten miles or [less].
H. H.: But you did run marathons at some point?
P. R.: Yeah, but I can’t do it anymore, because my back is just not that great.
H. H.: I’ve just gotta ask, what’s your personal best?
P. R.: Under three, high twos. I had a two hour and fifty-something.
H. H.: Holy smokes. All right, now you go down to Miami University…
P. R.: I was fast when I was younger, yeah.

Unlike policy outcomes, a race finishing time is a very straight-forward fact. One that cannot be subject to spin, just subject to excuses about why you ended up slower than expected or faster than expected. (I developed an injury while training for the marathon. Competing in a 24 hour adventure race during the marathon training re-injured my legs. Excuses, excuses…. but my finishing time is still my finishing time.)

I ask any of you who have run a marathon whether you remember your finishing time? Of course you do. Could Ryan have misspoken? Perhaps. Here’s what Ryan had to say in response:

“The race was more than 20 years ago, but my brother Tobin—who ran Boston last year—reminds me that he is the owner of the fastest marathon in the family and has never himself ran a sub-three. If I were to do any rounding, it would certainly be to four hours, not three. He gave me a good ribbing over this at dinner tonight.”

It was not a conventional news outlet but, rather, Runner’s World who looked into his claim and found it lacking. Maybe Ryan was looking to win the marathon runner demographic by throwing out an impressive finishing time. I suspect that he has lost the votes of most marathon runners. You can make excuses, but you can’t lie about your finishing time.

Any marathon runner will tell you the difference between a four-hour marathon and a sub-three hour marathon is enormous. For a non-runner it may seem easy to confuse or inconsequential. (I suspect political affiliation will also affect one’s view of this story.) Ryan is a self-proclaimed fitness nut. It should be nearly heartbreaking to be a minute over four hours rather than a minute under four hours. It’s only two minutes, but it’s the difference between having your time start with a “3” instead of a “4”. Starting with a “2” is only a distant dream at that point.

That two minute difference pits him against the last Republican vice presidential candidate.  Sarah Palin has run a marathon in 3:59.

That difference between a 3 and 4  has to be even more troubling when your brother runs marathons and has a better time than you. As his response pointed out, Ryan’s brother will not let him forget that he has the best marathon time in the family and it starts with a “3”, not a “2”.

One of my ongoing areas of interest is what makes an otherwise respectable business person turn into a white collar criminal. During my recent trip to FBI Headquarters,  Supervisory Special Agent Susan Kossler pointed out that two of the traits that distinguish a regular person from a white collar criminal is pathological dishonesty and little regret for misstatements. You look back at a Madoff or Stanford and wonder what led them from being legitimate, successful businessmen to start believing in their own lies and deception and become fraudsters. Even today neither expresses much remorse for their fraud.

People ask marathon runners about their finishing times. Look back at how easily Ryan responded to Hewitt’s question about his finishing time. Ryan, the fitness nut, must have been asked that question many times and responded many times  (dozens? hundreds? of times). When did he stop responding with “four hours” and start  saying “almost four hours”? Or “three and a half hours”? And then “a two hour and fifty-something”? When did one marathon turn into the plural “marathons”?

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