In a move that brings a sigh of relief more audible from Main Street than Wall Street, the Senate approved a bipartisan amendment to its financial reform bill to preserve the viability of the registration exemption most frequently used to raise capital for early stage companies.
Currently, the Securities and Exchange Commission (SEC) allows any company to sell securities in a private offering to “accredited investors” without registration pursuant to Rule 506 of Regulation D. The Senate financial reform legislation (the Dodd Bill), in its originally proposed form, would have directed the SEC to significantly increase the $1 million net worth and $200,000 annual income thresholds for individuals to qualify as accredited investors. As our Life Sciences group previously reported, such a change would have dramatically decreased the pool of accredited investors and made it much more difficult for early stage companies to raise needed capital. The amendment maintains the current accredited investor thresholds but directs the SEC to exclude from the net worth calculation the value of an investor’s primary residence. The amendment allows the SEC to review accredited investor standards for adjustment and modification, but the $1 million net worth standard will be in place for four years.
Companies should still be permitted to accept an individual investor’s self-certification that he or she satisfies the new net worth accredited investor standard absent a reason to suspect otherwise.
The amendment also deletes a requirement that Regulation D offerings be registered with the SEC and subjected to a 120-day SEC review period and potential review by state securities administrators. This feature would have increased the time required to complete a Rule 506 offering by up to at least four months.
While some angel investors may no longer qualify as accredited investors if the value of their primary residence is deducted from their net worth calculation, we believe the amendment is a better compromise between investor protection and the public interest in funding innovation than the pre-amendment version.
The amendment adds a “bad boy” provision to Rule 506, prohibiting persons cited for securities fraud or violations of banking or insurance regulations at any time during the previous 10 years from participating in the offering. State securities administrators could apply their own bad boy provisions. Since many states define even technical violations as “fraudulent, manipulative, or deceptive,” this could give each state a new veto power over some Rule 506 offerings.
To read more about the Dodd Bill, its context and other regulatory developments, click here.
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