by Dan Rosen, Joe Wallin and William Carleton
As we have previously blogged, Senator Dodd’s financial reform bill has posed a grave threat to angel investment and startup communities nationwide by virtue of two provisions in the bill that would have upended Regulation D. These “reforms” were ostensibly to address the problem of unscrupulous brokers, dealers, and promoters who have abused Reg D to defraud investors. The problem was, the provisions in Sen. Dodd’s bill were unnecessarily broad. Fraud is uncommon in angel investment transactions, and there were other ways to reform Reg D without gutting the rule that is working well to make startup and angel financing safe and efficient.
Here’s a quick refresher on the two problematic provisions in Sen. Dodd’s bill, problematic for startups and angels. The first provision would have adjusted the threshold at which angels qualify as “accredited investors,” sending two-thirds of active angel investors in the United States to the sidelines, ineligible to participate in getting startups off the ground. The second provision would have required companies to wait 120 days for the SEC to determine if they qualify for a securities law exemption that is self-executing (meaning, no waiting) today.
Well, whatever the outcome for the overall financial regulatory reform legislation now being debated in the US Senate, it appears that the startup and angel investing community can breathe a huge sigh of relief this week.
That’s because it now appears that Reg D will survive largely intact.
In fact, Reg D may be amended in a way that will improve it.
The below table compares what had been proposed with amendments now making their way to the Senate floor. We believe the amendments to save angel investing and startup financing will be sponsored by Sen. Dodd himself. The sound policy represented by these amendments was achieved largely through the efforts of the Angel Capital Association, under the leadership of its Executive Director, Marianne Hudson, supported by the ACA members’ contacts with Senators and their staffs.
|Original Proposal||New Proposal|
|Adjust Accredited Investor Thresholds
As originally proposed, would have adjusted the accredited investor financial thresholds for inflation since the thresholds were first set. This would have eliminated approximately 2/3rds of angel investors currently active. In addition, the first proposal would have required an adjustment every 5 years.
|Adjust Accredited Investor Thresholds
As now proposed, the net worth standard for an accredited investor will stay at $1,000,000, which is where it is now, with one important change: net worth will exclude the value of a person’s primary residence.
In addition, the bill would require the SEC to review the accredited investor definition to determine if it should be adjusted. The first review would be within 6 months, and thereafter reviews would be not less than frequently than every 4 years. Significantly, the new language also requires the SEC to consider the economic impact of any change, arguably leaving the door open for a future decrease in the accredited investor thresholds.
|SEC Review of Filings
As proposed in the bill approved by committee, would have required the SEC to review all accredited investor offerings within 120 days of the filing with the SEC. If the SEC did not undertake that review in time, states would have been free to impose their own rules.
|Disqualifications for “Bad Actors”
To date, the legislative process has worked better than we imagined it could. The language of the amendments saves angel investing, keeps costs for startups where they are now (still not low enough!), and gives state regulators the green light they need to pursue the fraudulent broker dealers and scam artists who have abused Reg D. (No responsible member of the start-up ecosystem would want fraud to take cover under Reg D; that favors no one and, as members of the startup and angel investing community, we hate bad behavior as much as any group of citizens.) The angel investing community was able to focus the attention of the Senate Banking Committee on preserving what works well now, while meeting the direct problem that concerned state securities regulators. All of this was supported, in the background, by Senators and their staffs who “got it.” We also believe that Congressional staffers who tweet could see the groundswell of rising consciousness on the issue among entrepreneurs. Architects of this effective social media effort included Matt LeVeck and Irene Tamaru.
The new reforms are not law yet, so we must remain vigilant. The sections could be further amended on the floor of the Senate, putting harmful provisions back in the bill or changing the provisions once again. If the bill is passed by the Senate, it would yet need to go through a reconciliation process with the House; and other action by the House could effect changes. So we’re not letting our guard down yet. But we are saying, it’s time to tell your representatives that you thank them for listening, and that you’re keeping watch on how this finishes.