By Khurshid Khoja
This is the second column in a two-part series
In my last column I discussed how the JOBS Act might ease the regulatory burden on ancillary business startups and early-stage companies seeking investment capital. In this column, I’ll elaborate on the JOBS Act’s relaxation of the “general solicitation” ban and its impact on ancillary companies and the angel investors that fund them.
But first, a quick primer on securities law, which will help you understand the rest of this piece.
The Securities and Exchange Commission (SEC) regulates the issuance of securities, including shares of stock in privately owned companies. Publicly held companies — whose stock is traded on a national stock exchange and available for sale to the general public — have a higher disclosure burden than privately held firms. In other words, publicly traded companies must provide a wealth of information on a regular basis about their financial health and projections for the future. They also must register with the SEC.
Privately held companies, on the other hand, are allowed to offer stock for sale to a limited number of accredited investors without being required to register with the SEC, but only if they fall within an exemption.
Relaxing the Ad Ban on Private Stock Offerings
The ban on general solicitation formerly prevented a private company from advertising the sale of securities offered under the Regulation D (or “Reg D”) exemption. This ban has become unenforceable in the social media age, as companies use Twitter, Facebook and LinkedIn to communicate the latest company developments. When these social media updates promote a company’s latest private stock offering, they also likely constitute prohibited advertising to the general public. Angel groups may complicate matters by publicly discussing the latest private offerings they evaluate, thereby compromising the issuing companies’ Reg D exemptions and exposing them to liability under federal securities laws.
Title II of the JOBS Act relaxes the general solicitation ban on companies issuing stock offerings and creates a “safe harbor” for angel groups facilitating those offerings through online platforms. The new law is relatively straightforward, saying that an issuer won’t lose their Reg D exemption by advertising. But there’s a caveat: The eventual purchasers of the advertised stock must meet certain annual income and net worth requirements, qualifying them as “accredited” investors. “Additionally, issuers will be required “to take reasonable steps to verify that purchasers . . . are accredited investors, . . . as determined by the [SEC].”
Unfortunately, we won’t know what these “reasonable steps” are until the SEC issues its final rules implementing Title II. Under the terms of the JOBS ACT, the SEC was required to issue these rules on July 4; however, SEC Chairwoman Mary Schapiro recently testified that the rulemaking would be delayed, without setting a new deadline. Thus, no one should rely on the relaxation of the general solicitation ban as an invitation to start tweeting about their deals until the SEC issues its final rules.
A Safe Harbor for Angel Groups
Given the JOBS Act’s restrictions on crowdfunding portals and the ongoing ban on advertising crowdfunded offerings (discussed in the first column), the safe harbor provisions are especially impactful for angels and start-ups. These provisions permit angel groups to adopt the most attractive features of the crowdfunding model—first and foremost, the ability to promote and facilitate an online sale of private securities to a broader investor base. But they also pave the way for collaborative due diligence and other benefits.
Specifically, the safe harbor provisions permit angel groups to maintain an online platform allowing startups to offer, negotiate and consummate the sale of their stock to private investors, without requiring a broker-dealer’s license from the SEC if certain conditions are met. The safe harbor provisions apply even if the group co-invests in such securities, or provides ancillary services such as due diligence in connection with the sale of such securities, though restrictions on collecting commissions and negotiating deals for members would still apply.
Opportunities for Industry-Led Angel Groups
Though angel groups will have the ability to have their member companies offer stock for sale via their group’s own Internet platforms, these groups may not collect any transaction-based sales commissions per the safe harbor provisions. Some in the venture capital industry speculate that many investment banks (with subsidiaries licensed as broker-dealers) will set up such platforms to help fund and develop promising young startups into future paying clients of their banks. However, it’s unlikely that the investment banks will create such platforms for ancillary companies in the medical cannabis industry in the near term.
Given this absence, reputable medical cannabis industry-led angel groups like the ArcView Angel Network (“AAN”) could act to fill the vacuum. While some angel groups may find it unprofitable to set up these platforms for Reg D offerings due to the cost of complying with the SEC’s investor verification rules, those angel groups that successfully monetize permissible services to member companies and investors could thrive by setting up specialty platforms for our industry.
Khurshid Khoja is the principal and founder of Greenbridge Corporate Counsel and currently serves as the outside general counsel to The Emerald Growers Association and the ArcView Group. The information contained in this column does not constitute legal advice or a legal opinion and should not be viewed as a substitute for either.