More than a year after its congressionally set deadline, the SEC voted 4-1 Wednesday to lift the ban on general solicitations for Rules 506 and 144A private offerings – one of the key provisions of the Jumpstart Our Business Startups (JOBS) Act.

But in response to concerns about the potential for fraud, the commission unanimously passed a rule disqualifying some felons and other bad actors from participating in the markets and voted 3-2 to propose a package of amendments to Regulation D, Form D and Rule 156 that could make private offerings much more burdensome for small biotechs.

Voting against the proposal, Commissioners Troy Paredes and Daniel Gallagher said, if implemented, the amended regulations would undermine the JOBS Act, making capital formation even more difficult for emerging growth companies.

SEC staff recommended the amendments so the SEC could better assess the impact of removing the ban on general solicitation and help protect investors. The proposal includes such measures as requiring Form D to be filed at least 15 days prior to a general solicitation and another form to be filed within 30 days of completing an offering. It also calls for a new, two-year rule requiring companies to submit their general solicitations to the SEC. If companies don't comply with the requirements, they could be disqualified from Rule 506 offerings.

The rationale behind the proposal is that the required reporting would increase the quantity and quality of data the SEC receives about private issuers and offerings. The staff recognized that the proposed changes would increase the regulatory burden for small companies, but they claimed the benefits would justify the higher cost of compliance.

Paredes disagreed, saying the "totality of what the commission is proposing would jeopardize the vitality" of future capital formation for small companies and would thwart the role of private offerings as an efficient means of raising capital.

He added that he would find it troubling if the SEC responded to the mandates of the bipartisan JOBS Act by imposing a more burdensome regulatory regime.

Gallagher noted that three times as much capital is raised under Rule 506 as through public offerings. But the amendments the other commissioners voted to propose would make private offerings as burdensome as public ones. Yet the intent of the JOBS Act was to lessen the regulatory stranglehold on small companies.

The commissioners were much more agreed on making the change, required by the JOBS Act, to Rule 506 under Regulation D, and Rule 144A to permit general solicitation and advertising, provided purchasers are accredited investors and the issuer takes "reasonable steps" to verify that fact. The rule passed by the SEC includes a nonexclusive list of verification methods the issuer can use to ensure an investor is accredited. It also requires a box for investors to check indicating that they are accredited.

With more than 70 percent of the biotech industry being private, biotech companies were particularly interested in the changes to Regulation D, Kenneth Moch, president and CEO of Chimerix Inc., testified before a House subcommittee Wednesday on behalf of the Biotechnology Industry Organization (BIO). The subcommittee hearing on capital formation ran simultaneously with the SEC meeting.

In passing the JOBS Act, Congress gave the SEC until July 4, 2012, to lift the general solicitation ban, which was originally imposed in 1982 to safeguard investors. Widely used by U.S. and foreign issuers to raise capital without registering their offerings, Rule 506 is a large contributor to capital formation. More than $1 trillion worth of capital was raised in 506 offerings in 2011 alone, and the median offering raised was about $2 million. (See BioWorld Today, Aug. 30, 2012.)

Protecting Investors

Much of the SEC's delay in changing the rules stemmed from concerns about protecting investors from "bad actors." The new rule will bring significant changes to private offerings and enhance the opportunity to raise capital efficiently, Commissioner Elisse Walter said in voting for the rule. However, it could have unintended consequences, she added.

"The world looks very different than it did in 1982 when Reg D was implemented," Walter said, especially when it comes to how people communicate. Those changes make increased SEC vigilance more important, she added.

That increased vigilance comes in the form of disqualifying bad actors, which is required under the Dodd-Frank reforms, and the proposed amendments to Regulation D, Form D and Rule 156. Walter stressed the importance of having bad actors disqualified at the same time the general solicitation ban is lifted.

"It is imperative that investors have confidence that the . . . market has not turned into the Wild West," she said.

Commissioner Luis Aguilar, the lone vote against lifting the ban on general solicitation, wasn't convinced the bad actor disqualification went far enough. And he said measures to further protect investors should have been included in the rule lifting the ban. "Investors should not be at risk any longer than necessary," he added.

Aguilar raised two objections to the rule to disqualify bad actors. First, it would not be retroactive. Only events that occur after the rule goes into effect will lead to disqualification. That means players who engaged in wrongful conduct today could still participate in the market.

He also objected because of the limited reach of the disqualification. For instance, it only applies to executive officers of a company.

Industry welcomed the SEC's vote to lift the ban on general solicitation, with BIO saying it would "stimulate fundraising for innovative biotechs by allowing them greater access to the investors who fund their groundbreaking R&D."

However, the trade organization is concerned about the SEC's proposal to require greater disclosures for private offerings. While it supports commonsense investor protections, it doesn't want to see overly burdensome regulations imposed on growing biotechs.

BIO said after it reviews the proposal, it will engage "with the SEC to ensure that the rules for Reg D offerings meet congressional intent as directed by the JOBS Act."

Editor's note: This is the first of a two-part series on capital formation. Part II will look at proposals Congress is considering to build on the achievements of the JOBS Act.