After much hubbub, the SEC rules allowing general solicitation of private placements under rule 506 of the ’33 Act are here (or, more precisely, will be here next Monday, September 23). Let’s first talk a little history.
Congress introduced the Securities Act of 1933 (the ’33 Act) in the aftermath of the stock market crash of 1929, which was triggered by a speculatuive bubble. The ‘33 Act, among other things, created the SEC and introduced the registration requirements (section 5 of the ’33 Act) for publicly offered securities. Thus, following the enactment of the ’33 Act, an issuer that wanted to offer its securities to the public needed to register the securities with the SEC. Needless to say, registration is costly, time-consuming, and triggers many ongoing obligations that have gotten more and more complex through the last few decades. This registration requirement for publicly offered securities is, save for a few exemptions, still the law of the land.
Recognizing that the registration process was lengthy and costly, Congress provided a few exemptions. One of these exemptions (Section 4(2) of the ’33 Act) allowed certain “private” transactions to be conducted outside of the registration requirements of Section 5. This exemption is what gave rise in subsequent years to rule 506 (part of Regulation D) and is the regulatory regime on which GroundBreaker principally relies to conduct its “proprietary” business. Under rule 506, issuers can sell securities to investors with whom they have a pre-existing relationship and who meet a certain income or net worth requirements.
One can easily see the rationale for the requirements of rule 506: (a) the transaction is not public so the damage will be contained, (b) issuers are less likely to defraud a close friend, relative, or people in their network, (c) well-to-do folks are likely to be better educated, have better advisors, and fare better should they lose money. However, the unintended consequences of rule 506 were that the more lucrative, private investment opportunities were kept to the rich folks with a country club membership. What was intended to protect investors ended up denying them access to some of the best deals out there: the SEC fenced off the kitchen so kids didn’t play with fire.
The JOBS Act, which was passed in 2012, seeks to reverse this trend by allowing rule 506 transactions to be advertised to the general public. There are a few strings attached, however, since issuers who choose to use the “new” rule 506 (rule 506(c)) can only sell their securities to those investors who are accredited (i.e. meet the income or net worth requirements). Basically, an issuer who chooses to advertise a deal, can no longer sell to a limited number of unaccredited investors, as permitted under the old regime. The good news is that the JOBS Act also introduced the concept of “crowdfunding,” which provides a mechanism for unaccredited investors to also invest in these deals. These crowdfunding rules, however, are still being drafted by the SEC and we do not expect them anytime soon.
Next Monday, I will explain what GroundBreaker is offering to real estate entrepreneurs who want to rely on the new rule 506(c) regime to fund their projects. For now, I will only say this: it’s the best deal out there, it will save you time and money, and it will make your life a hell of a lot easier. Stay tuned for more.