Startup Financing: SEC Sending Mixed Signals with ‘Bad Actor’ Rule?

We hate to be the ones to rain on your parade, but after yesterday’s sunny outlook on legislative and regulatory efforts to loosen restrictions on crowdfunding, we couldn’t help but notice an update today highlighting a different signal from the Securities and Exchange Commission: its proposed new “bad actor” rules that appear to contradict the stated desire to loosen restrictions on startup funding: 

“The Securities and Exchange Commission (SEC) has proposed new rules that will make it substantially more costly and difficult for startups and early stage companies to raise capital. These rules are designed to ensure that what they have labeled as “bad actors” are not involved in the securities offering business. No, these rules won’t spare you from any bad movies.

Why does this matter to you as the founder of or investor in a startup? Because your startups could be disabled from using Rule 506, the most commonly used securities law exemption by startups, because of these rules.

The SEC’s proposed “bad actor” rules are so onerous that four committees of the American Bar Association manned with very busy people took the time to publish a 23 page letter to the SEC plan in October of this year criticizing many important aspects of this proposal. The ABA letter said:

‘We are particularly concerned that an overly broad implementation of the Section 926 [“bad actor”] directive could undermine the utility of Rule 506 as the most widely used exemptive safe harbor for private placements of securities, thereby materially and adversely affecting the ability of many companies, including many private companies and smaller reporting companies, to obtain capital’.

Now, no one would argue that keeping ‘bad actors’ out of the securities offering business is a bad idea. The problem is the new rules are regulatory overkill. They are especially too much for small companies that are raising small amounts of money.

In short, the proposed rules will punish a lot of good people in order to get the bad people. This is bad policy.

Read the full update: SEC Proposed “Bad Actor” Rules: Hard On Startups And Early Stage Companies by Davis Wright Tremaine LLP 

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For more on the ‘Bad Actor’ rule, also see:

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