A LOOK AT THE PRACTICAL IMPLICATIONS OF THE NEW JOBS ACT RULES ON - PDF document

“A LOOK AT THE PRACTICAL IMPLICATIONS OF THE NEW JOBS ACT RULES ON PRIVATE OFFERINGS OF SECURITIES” December 4, 2013 Materials Written By: Nicholas J. Bakatsias, JD, LL.M. Carruthers & Roth, P.A. P.O. Box 540 Greensboro, NC 27402 (336) 379-8651 njb@crlaw.com *Materials reflect updates to 2012 Carruthers & Roth, P.A. Seminar manuscript titled “Promising Rain But Delivering Only Blue Skies – A CPA’s Guide to the State and Federal Securities Laws”, following SEC adoption of the JOBS Act implementing rules 1

TABLE OF CONTENTS I. Introduction II. Overview of Securities Regulation Policies A. Balancing Capital Investment Promotion vs. Need for Regulation B. General Overview of Current Registration Requirements C. Passage of the Jobs Act III. What Constitutes a Security? A. In General B. Investments Contracts – the “Catchall” of Securities C. Partnership Interests D. LLC Membership Interests E. Sale of Business Structured as a Stock Sale F. Promissory Notes IV. Overview of the Federal Securities Registration Laws A. Background B. Examination of the Exemptions to Registration 1. The Intrastate Offering Exemption 2. The Private Offering Exemption 3. Regulation A – “The Small Public Offering Exemption” 4. Regulation D Exemptions 5. Who Qualifies as an “Accredited Investor” 6. Form D Filing V. Overview of the North Carolina Blue Sky Laws A. In General B. “Securities” under North Carolina Blue Sky Laws C. Registration Requirements D. North Carolina Exemptions E. Notice Filing Requirements F. North Carolina’s Direct Participation Rules G. North Carolina Enforcement of Securities Violations VI. Overview of Broker-Dealer Registration Rules A. Introduction B. Federal Broker-Dealer Registration Requirements C. Use of “Finders” to Attract Investors D. Use of Finders under SEC Scrutiny E. North Carolina’s Broker-Dealer Registration Requirements VII. Overview of the Recently Enacted JOBS Act A. In General B. Modifications to Regulation A Offerings C. The New Crowdfunding Exemption 1. In General 2. Issuer Disclosure Requirements 3. Intermediary Rules and Regulations D. Removal of Prohibition on General Solicitation in Rule 506 Offerings E. Requirements of New Rule 506(c) F. F. Bad Actor Disqualification under New Rules 506(d) and (e) G. Advantages of New Rule 506(c) H. Changes to Exchange Act Registration Requirements I. Finding Investors in the New JOBS Act Regime J. Effect of Increased SEC Finder Scrutiny on Trading Platforms K. The “Real” Crowdfunding Exemption – “Public Private Offerings” VIII. Conclusion 2

I. Introduction. It’s no secret that revitalizing a slumping economy often requires, among other things, stimulating small business markets with the infusion of capital. Well functioning capital markets enhance the development of the small business community, which in turn spurs job growth and economic recovery. However, when banking institutions are hesitant to provide adequate financing to fledging or struggling companies on reasonable terms, attracting equity capital can be a difficult endeavor for many such small businesses. Consequently, small business owners often look to family and friends, angel investors or third party investment options to solicit the funds needed to finance the start-up and/or growth of their businesses - yet these options have also been limited during the recent destructive recession that has plagued the global economy. In an effort to revive the United States national and state economies and foster responsible job growth, in late 2011, Congress examined various legislative proposals designed to make the capital formation process more efficient and less expensive to aspiring entrepreneurs. While expanding the reach of equity markets to small businesses through the reduction of barriers to capital investment is certainly desirable, an unregulated investment environment can increase the incidence of securities fraud and reduce investor protection. Just as increasing small business investments can provide an economic stimulus and encourage growth in the employment sector when done properly, there is also the possibility of undermining market integrity and punishing Main Street investors if done recklessly. Balancing (i) the need for more accessible and less expensive capital formation options through a less burdensome regulatory environment against (ii) the need to maintain investor protection against fraudulent actors and promote investor confidence, has been the overarching objective of state and federal securities regulations over the last one hundred years or so, particularly leading up to the passage of the JOBS Act discussed below. Under the current regulatory landscape, whenever a business seeks to attract outside capital by selling equity interests to investors, the enterprise basically has two choices: (i) register the securities with the SEC and the applicable state securities authorities, or (ii) find an exemption from registration under the federal and state securities laws. Securities registration can be an extremely time-consuming effort that is often prohibitively expensive for many small businesses, thereby leaving exemption qualification as the more attractive option. As discussed in more detail throughout this paper, if a business does not fit within the parameters of a registration exemption, and fails to properly register the securities, its investors may be able to recover, at a minimum, their entire investment, even if the soliciting business did not intentionally mislead the investors or engage in any other illegal behavior. Given the convoluted nature of the current securities regulation framework, capital- seeking businesses are well advised to seek qualified legal and accounting advice before proceeding with any plan to raise capital through equity sales. In addition to the securities registration laws, businesses that make overly optimistic promises to investors may also find themselves embroiled in an expensive and drawn out securities fraud lawsuit. 3

The remainder of this paper will provide an overview of the current securities registration requirements and attendant exemptions with an aim towards assisting small businesses and their professional advisors successfully navigate through the capital formation process. In addition, this manuscript will summarize the key features of the “Jumpstart Our Businesses Startups Act” (the “JOBS Act”), and examine how the recently enacted implementing regulations will impact the private offerings of securities in the future. As posited below, the impact of the new JOBS Act rules on the securities market is likely to be substantial. II. Overview of Securities Regulation Policies A. Balancing Capital Investment Promotion against the Need for Regulation. The title of the prior version of this manuscript (“Promising Rain but Delivering Only Blue Skies”) alluded to the initial efforts of states to find the appropriate balance between investor protection and investment growth within the federal regulatory framework that controlled investment solicitations in the early part of the twentieth century. While the current regulatory canvas is a complimentary regime of both state and federal securities rules, federal authorities initially had a monopoly on regulation until Kansas enacted the first state- promulgated investor protection statutes known as “Blue Sky laws” in 1911. Historians point to the legislative measures designed by Kansas legislators to protect unsuspecting local farmers (or their widows) against wild investment schemes promoting untested contraptions that promised to induce atmospheric rain, but delivered only “blue skies” 1 , as a seminal moment in the history of securities offerings regulation. Unfortunately, the current labyrinth of federal and state rules and regulations restricting the transferability of stock, limited liability company membership interests, and other equity interests in businesses has not made it easy to achieve that balance. For the most part, the federal and state laws do not match up well, and contain widely varying sets of rules, restrictions, safe harbors, and boundaries of which a capital-seeking business must be cognizant. Generally, these regulations are indiscriminate as between large corporations and small, growing businesses, and apply to most businesses forms equally. Dangerously, many small companies (and even their professional advisors) often assume that the Securities and Exchange Commission ("SEC") and the applicable state securities divisions will simply overlook offerings by small companies. Perhaps leading to the enactment of the JOBS Act, as discussed below, many economists and politicians alike argued that advancing the economic recovery required greater access to capital for small businesses with less regulatory oversight. An alarming number of businesses have failed since the near-financial collapse of 2008 - not as a result of any operational deficiencies or limitations in their ability to competitively operate, but rather as a direct result of their inability to obtain bank loans or other outside capital infusions. The theory promoting deregulation rests on the principal that a more relaxed regulatory environment encourages capital investment yielding high returns and sustained economic growth, since regulatory roadblocks 1 See Fleming, Rick and Bob Webster, “A Century of Investor Protection ”, North American Securities Administration Association (2011). 4