by Eric Malloff

The Jumpstart Our Business Startups Act or “JOBS” was signed into law on April 5, 2012. Contained in the JOBS Act are several mandates that liberalize Securities and Exchange Commission (“SEC”) rules governing when and how a “small business” may raise capital through the issuance of securities.

Among the new mandates, the JOBS Act requires the SEC to loosen rules governing private placements, or Regulation D (“Reg. D”) offerings. One of the more notable liberalizations is the rescission of the prohibition against general solicitation for private placements relying on the safe harbor provided in ’33 Act § 4(a)(3), or Rule 506 offerings, contained in ’33 Act Rule 502(c). However, under JOBS a Rule 506 offering is still prohibited from general solicitation when any non-accredited investor purchases such offerings. Furthermore, the JOBS act requires the “issuer take reasonable steps to verify that the purchasers of the securities are accredited investors.”

While this change represents only a small part of the changes under JOBS it is nonetheless significant. Prior to JOBS, Rule 506 issuers had to rely upon their own network of interested parties. Conversely, JOBS allows these same issuers to advertise and seek public interest in their securities so long as they reasonably believe the purchaser to be an accredited investor. This begs the question whether we will soon start seeing various securities touted across the television smashed between an ad for our favorite cereal and those kid’s toys that seems extraordinary but always disappoint.

While freeing market cash flows and encouraging capital investment in new ventures is essential to continued economic growth, I am not convinced that a conditional rescission of Rule 502(c) is the best methodology for accomplishing that goal. I am generally concerned that these changes may result in private equities markets rife with fraud. The question remains, will this tactic create capital fluidity or stifle unaware investors with junk equity.

One possible safeguard is the inclusion of a provision prohibiting non-registered parties from profiting from the sale of securities or ancillary services associated with a Rule 506 issue. Nevertheless, this does not place any prohibition on registered broker-dealers.

The key to JOBS’s success will be the post review and comment regulation and enforcement by the SEC. As always, it is worthwhile to take a close look when considering any private placement offering: especially with the anticipated increased prevalence of Rule 506 issues in the marketplace.

By Amber Eanes

President Obama signed the JOBS Act bill in April 2012, but it has yet to take full effect as we wait for the SEC to develop regulations. The purpose of the JOBS Act is to enable small businesses and startups to raise capital and gather investors through crowd-funding: selling small amounts of equity to many investors in order to fund a company.

The idea behind the legislation is to increase the American emerging markets sector. This sector in the United States officially includes “emerging growth companies,” which is defined by the SEC as a company with less than $1 billion in total gross revenue on a yearly basis. If you consider participating in crowd-funding, it is important to remember that extra risk is associated with these emerging growth companies. While you may be investing smaller amounts of capital in these startups it is highly likely that if you lose, you will lose everything. For instance, 85% of small businesses will fail within the first year, showing the higher risk of a total loss when putting equity into these small startups.

The JOBS Act is pioneering legislation because it is the first time individual investors in the United States will actually be able to purchase equity in startup companies that have not gone through the expense of SEC registration. The novelty of the act increases the need for the SEC to regulate in a way that balances investor protection with the interests of small business owners seeking to raise capital, as we do not know how either will be affected. Without appropriate regulation, the legislation could end badly with possible scams and exploitation of unsophisticated investors. The SEC is supposed to have its regulations for implementation in place by December 2013, but until this time investors should invest cautiously, taking into consideration the risk of total investment loss.