Rule 506(c) and the Impact on Demo Days

Joseph W. Bartlett, Special Counsel, McCarter & English, LLP

All of us know that, for a number of years, the ban on general solicitation in Section 502 of Reg D has been honored in the breach by very prestigious groups (and, of course, some that are not so prestigious) in the context of what are summarily referred to in these times as “Demo Days.”

The catch phrase includes events, in person or online, which feature issuers presenting themselves to a crowd of people in a variety of contexts but which, arguably, meet the definition in Rule 502(c): “Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.” The definition begs the question, of course … what is “general solicitation?” There are close questions, to be sure; but many of the most prestigious events proudly broadcast far and wide the distinguished nature of participants initially signed up and the hot young companies which will present, the sponsors promoting the event by, e.g., mass mailings and invitations published in trade journals. General Solicitation? Q.E.D.

I had a first conversation with the SEC Staff decades ago on this issue and mentioned that we were looking at a “crime wave,” which was the colorful point I made; but, the fact is that the SEC has not, as yet, elected to bring much in the way of proceedings against the organizers of such presentations to large crowds, many of whom are potential investors, even though the presenters include emerging growth companies seeking capital. Some of these events are styled as business plan competitions; others have air cover from affiliation with academia; and others have a long history in which hundreds of people are exposed to pitches each year. Indeed, as the Angel Capital Association’s November 4th comment letter points out: [1]

“All of these concerns would not be so high if the current description of general solicitation were not so broad, as essentially to include the large majority of angel-like offerings, and unfortunately to include some practices that have been in use for more than a decade without problems or fraud. If the proposed rules become effective, many startups will have a whole new regime of rules, filings, and penalties for doing the very same thing as thousands of entrepreneurs before them. Those particular startups are not getting new avenues for advertising their offerings and expanded access to capital – they’re just getting many more rules.

“Of particular concern is whether or how events such as demo days, venture forums, and business plan contests are considered to be part of 506(c) or 506(b). We have seen a wide variety of interpretations in the market about whether these events are general solicitation or not, but it appears that most of these events are general solicitation as they are meetings whose attendees have been invited by any general solicitation or general advertising.

“It would really help the startup ecosystem if the Commission provided more clarity on the definition of general solicitation, particularly related to these events. ACA notes that a large number of these events are hosted or sponsored by federal, state, and local government agencies, universities, non-profits that receive government funding, and law firms for the purposes of economic development and education – and that a number of them have been presented for many years.” (Emphasis added.)

To be sure, there is, as yet, no declared intent of the SEC and its Staff to do a U-turn and start to question event organizers that their methodologies for presenting business plans, in fact, violate any sensible, plain English definition of general solicitation. On the other hand, there is a pretty significant undercurrent indicating that the SEC’s attitude, with the advent of Rule 506(c) conditionally lifting the ban if all the investors are accredited,could be changing.    Thus, the SEC could be heard to say to the public at large something along the following lines:

“We have not closed in and brought an enforcement action for decades against a number of presentations and events we can group under the heading of Demo Days which violate the ban on general solicitation under any reasonable definition thereof because we have felt, among other things, that a number of these occurrences contribute to economic growth and are managed by prestigious overseers; thus, the need for anti-fraud enforcement proceedings has not been robust. That said, with the JOBS Act Title II 506(c) now opening up, any institution or group which wants to pursue general solicitation has an avenue to do so under specific rules as announced and warranted by this Agency. The path is now clear for presentations which do not have to concern themselves with the ban on general solicitation. And, since that path, in our view, is wide open, we are going to insist that the Reg D, Rule 506(b) option for such operations is no longer viable. We have shown sponsors of Demo Days the way they can do it under 506(c); we don’t  encourage the sponsors to assume that the SEC will continue to accommodate illegal pitches just because such rule ‘bending’ has been winked at in the past.”

The question is whether, post September 23rd, the issuers featured on Demo Days intend to comply with the 506(c) regulations and, if they don’t, will the SEC enforcement division step in? The two-part answer, in all probability, is: “It depends. And, stay tuned.”

In the meantime, and for the time being at least, the advice to clients from cautious lawyers is likely to be the traditional message:

“If you are going to be on the podium or the panel to discuss Newco, stick to the script. Talk about your products but do not mention in any way, shape or form that Newco is looking for investors. Indeed, stick to a business discussion … no financials and, particularly, no forecasts; stay away from language which is typically found in pitch materials. If a member of the audience asks if you are raising capital, politely demur … on the advice of counsel. When networking before and after your talk, collect business cards, but don’t pitch at the event. A subsequent phone call is in order. And, understand that the sky is gray in this area; we lack specific guidance from the rule makers and so our advice is practical … not a formal opinion based on bright line rules but the best anyone can do until the rules are (if ever) clarified.”

And, plainly, the Angel Capital Association comment should draw blood. Closing down events sponsored by not-for-profits interested in general economic development makes no sense. Indeed, there are rumblings that the SEC is considering some guidance. To repeat, please stay tuned.

[1] Angel Capital Association Nov. 4, 2013, letter to Elizabeth Murphy, Secretary, U.S. Securities and Exchange Commission.

Joseph W. Bartlett, Special Counsel,

Joseph W. Bartlett is special counsel in the Corporate, Securities and Financial Institutions practice. A recognized pioneer of the national private equity and venture capital bar, Mr. Bartlett contributed to the original models for private equity and fund of fund partnerships. His experience extends to alternative investments, venture capital, emerging companies, corporate restructurings, private equity and buyouts. Mr. Bartlett's practice includes serving as counsel to asset managers, including those of major public and private equity funds, with a focus on technology companies, and he has also served as trustee of a series of public mutual funds and chair of a public REIT. His venture fund work began with the first Greylock fund, and he has drafted documents for several of the largest and most successful LBO funds.

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