Under Congressional Mandate, SEC Slowly Moves Towards Recognition of First Amendment

Cross-posted at Forbes.com’s WLF contributor page

In a post last February, Supreme Court Cert Petition Spotlights Speech Limits on Securities Market, we urged the Justices to review a Massachusetts high court ruling which prevented communication about investment opportunities. The Court denied certiorari on May 14, but by that time, securities issuers like the petitioner in that case, Bulldog Investors, had a new, and improbable, champion for its speech rights—Congress.

The JOBS Act, which became law on April 5, includes a provision ordering the Securities and Exchange Commission (SEC) to eliminate a rule prohibiting “general solicitation” in situations where “accredited investors” are participating in the offering process. The prohibition takes the form of a condition for certain securities offerings. Under Rule 506 of SEC Regulation D, issuers who target accredited investors (i.e. rich and sophisticated persons and entities) and who refrain from solicitation (i.e. direct marketing, print or broadcast ads, websites, seminars) don’t have to register their offerings with the SEC. In other words, the issuers only get a benefit (no registration) if they surrender their speech rights.

As Bulldog Investors argued in its cert petition, such limitations tread on issuers’ commercial speech rights and are a significant impediment in the formation of capital, especially for startups. SEC’s own Advisory Company on Smaller Public Companies concurred with the latter point, as did Congress when it drafted the JOBS Act. The Act ordered SEC to eliminate the speech restraint within 90 days.

On August 29, almost a month past Congress’s deadline, SEC published a proposed rule to eliminate the prohibition on solicitation. Certain SEC Commissioners and Members of Congress have criticized SEC for its tardiness and for delaying action at least another 30 days (the duration of the comment period). SEC Chairman Schapiro seems sympathetic to the concerns voiced in letters from various activist groups that freer speech will unleash a flood of fraudulent activity.

In the proposed rule’s economic assessment, SEC noted the possibility of an increase in fraud but provided no supporting empirical or anecdotal evidence. The Commission did acknowledge the strong economic reasons for removing the speech ban, including increased access to capital, lower transaction costs, and more efficient pricing.

To ensure that the information is targeted at sophisticated investors, the JOBS Act requires that securities issuers take “reasonable steps” to verify that the investors are accredited. In its proposal, SEC declined activists’ demands to impose strict verification requirements, opting instead for an objective standard based on each situation’s facts and circumstances. In seeking comments, however, the Commission did ask whether “certain types of issuers” should face a heightened verification test.

Such a potential for speaker-based discrimination on lawful communication, along with the Commission’s reluctant, plodding pace, should concern those who pursued these welcome changes to the securities laws. Old regulatory habits die hard, and the activists who have opposed speech liberalization are deeply invested (no pun intended) in government’s suffocating control over securities markets. Investors, entrepreneurs, and others who supported the JOBS Act must keep SEC on the path its August 29 proposed rule sets out.

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