Does the SEC rule the job creation roost? Squaring SEC rulemaking with the JOBS Act's relaxation of the prohibition against general solicitation and advertising.

• Author: Derman, Jeremy
• Position: Jumpstart Our Business Startups Act

"[I]f an entrepreneur can't get a loan from a bank or backing from investors, it's almost impossible to get their businesses off the ground.... I called on Congress to remove a number of barriers that were preventing aspiring entrepreneurs from getting funding.

... [F]or start-ups and small businesses, this bill is a potential game changer.... [S]tart-ups and small business will now have access to a big, new pool of potential investors.... [O]rdinary Americans will be able to go online and invest in entrepreneurs that they believe in.

Of course, to make sure Americans don't get taken advantage of, the websites where folks will go to fund all these start-ups and small businesses will be subject to rigorous oversight. The SEC is going to play an important role in implementing this bill." (1)

1. Introduction

   As of April 2012, 12.5 million Americans were unemployed and the domestic economy remained stagnant. (2) While the U.S. economy struggles to pull itself out of a recession, perhaps taking a lesson from history, Congress has focused on small-business job creation as a means of stimulating the economy. (3) The latest congressional scheme deregulates the capital markets to permit emerging growth companies (EGCs) greater access to investment funding, thereby fostering small-business growth, and ultimately creating more U.S. jobs in the process. (4) Specifically, in 2012, Congress enacted the Jumpstart Our Business Startups Act (JOBS Act) to carry out its economic policy objectives. (5)

   Opening the capital markets to EGCs, however, comes at a cost--namely the potential defrauding of investors. (6) Prior to the JOBS Act, start-up businesses were prohibited from undertaking general solicitation and advertising--certain types of investment marketing techniques--to recruit investor funding. (7) Nevertheless, a faction of legal scholars and small-business advocates has apparently succeeded in persuading Congress that the prohibition causes more economic harm than good. (8) Additionally, in the legislation, Congress dictated that the Securities and Exchange Commission (SEC) will play a pivotal role in implementing the JOBS Act's regulatory reforms. (9)

   The SEC is tasked, inter alia, with promulgating rules to protect investors, which includes remediating fraud in connection with the purchase and sale of securities. (10) Complicating matters, the JOBS Act requires the SEC to relax the prohibition against general solicitation--a rule it promulgated to prevent the defrauding of investors--while simultaneously instituting new rules to achieve the same fraud deterrence under a relaxed regulatory system in which general solicitation is permitted. (11) The great discretion the SEC is afforded presents a potential impasse for an EGC challenging the SEC's rulemaking authority under the JOBS Act if that authority was to arguably conflict with Congress's intent in enacting it. (12) Because Congress's scheme is designed around promoting capital formation through deregulation to incite small-business job creation, the SEC's regulatory function, particularly in creating new rules, could influence the JOBS Act's success in economic terms. (13)

   This Note will proceed as follows: Part II.A traces the evolution of securities regulation law in the United States up to today's capital raising procedures, focusing on the legal requirements start-up businesses, like EGCs, must adhere to when pursuing investment capital. (14) Next, Part II.B studies the JOBS Act and its purported purpose insofar as affording EGCs with greater access to the capital markets. (15) Part II.C examines the significant role the SEC will play in both providing these businesses with improved access to capital as the JOBS Act directs, and protecting those who invest in them from fraud. (16) Finally, Part III questions the SEC's discretion under its rulemaking function, and illuminates an inefficiency the JOBS Act creates as a form of government regulation: because the SEC is tasked with facilitating conflicting regulations regarding general solicitation, it may be immune from a putative challenge to part of its post-JOBS Act authority. (17) The implications of the SEC's broad discretion with respect to the rules it promulgates are significant in terms of the legacy of the JOBS Act--that is, its effectiveness in creating American jobs-and, inferentially, whether it can be considered an economically beneficial form of government regulation. (18)

2. HISTORY

   1. The Securities Regulation Landscape

      The field of securities regulation lies at the intersection of law and economics. (19) While the notion of efficient, self-regulating capital markets is a central tenet of free-market economic theory, for pragmatic reasons, government regulatory intervention is often necessary to ensure proper market functionality. (20) Accordingly, Congress does not shy away from enacting legislation regulating the U.S. capital markets to carry out its economic policy objectives. (21) Moreover, Congress often justifies favoring small businesses through such legislation based on the proposition that encouraging these ventures is beneficial to the domestic economy. (22) In assessing the economic effectiveness of the legislation, the government would be viewed as properly intervening where there is agreement that the benefits from such intervention outweigh the costs. (23)

      1. The '33 Act and the Rise of the SEC

         The Great Depression during the 1930s was primarily responsible for initiating modern federal regulation of the U.S. securities markets. (24) In fact, the transformation of the U.S. business climate from laissez faire economics to pervasive regulation can be attributed to the New Deal legislation of the 1930s. (25) Leading up to the stock market crash of October 1929 and the ensuing Great Depression, American capital markets went largely unregulated. (26) Following the crash, Congress made stimulating the sluggish economy its top priority, and passed the Securities Act of 1933 ('33 Act) (27) and the Securities Exchange Act of 1934 (Exchange Act). (28) Congress, however, needed to delegate the task of administering and enforcing the securities laws that it had implemented, due in large part to both the complexity of the securities markets and their fundamental importance to the economy. (29) Consequently, Congress created the SEC. (30)

         The SEC's mission is to "protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation." (31) During the Great Depression, Congress was principally concerned with restoring public confidence in the capital markets, and instituted the SEC as the mechanism for doing so. (32) Today, SEC enforcement of the securities laws--especially those found within the '33 Act--and its associated rulemaking authority continues to influence the U.S. economy, particularly in the area of capital formation. (33)

         The '33 Act marked the first federal legislative attempt aimed at remediating abuses in the sale of securities. (34) Fundamental to the Act's regulatory framework is the notion that full disclosure of all material characteristics of securities being marketed provides sufficient investor protection because it enables investors to evaluate the merits of potential investments. (35) Under the '33 Act, any offer to buy or sell a security through interstate commerce is prohibited unless specified registration and prospectus delivery requirements are met. (36) Before considering the Act's strictures, it is important to distinguish the '33 Act's registration requirements for transacting in securities (i.e., purchasing and selling securities) from state "Blue Sky" laws, which, among other things, govern the registration requirements for the securities themselves. (37)

         An issuer's potential liability for violating the '33 Act is mainly limited in two ways. (38) First, the provisions of the '33 Act are not applicable unless there is a link between an aspect of the transaction and the use of channels of interstate commerce, such as where an issuer attempts to sell securities by mass mailing marketing literature to prospective purchasers across the United States. (39) The second limitation follows from the '33 Act's bifurcated regulatory scheme for the offering and sale of securities, that is, the offer and sale must either be registered with the SEC or subject to a registration exemption. (40) If the offeror is able to prove that one of the exemptions covers the offering in question, then the '33 Act's registration and prospectus delivery requirements do not apply to the transaction. (41) Therefore, under the '33 Act, an offering of securities can only belong to one of three categories: registered, exempt, or illegal. (42)

      2. Private Placements and Exempt Offerings in the EGC Capital-Raising Process

         Sections 3 and 4 of the '33 Act authorize two principal statutory-based exemptions from registration for offerings of securities. (43) Section 3 permits the SEC to exempt issuances of securities with a total value less than five million dollars. (44) Under section 4's safe harbor provision, an issuer's transaction that does not involve a public offering may also be exempted. (45)

         Regulation D, comprised of rules 501 through 508, and codified pursuant to sections 3 and 4 of the '33 Act, is particularly relevant to EGCs because it provides certain issuers with limited offering exemptions from the registration and prospectus delivery requirements that are otherwise necessary under section 5. (46) The SEC promulgated Regulation D after evaluating the effects of its rules on the ability of small businesses to raise capital, and accordingly, the issuers that Regulation D applies to include small businesses, like EGCs. (47) Regulation D's purpose is "to simplify and clarify existing exemptions, to expand their availability, and to achieve uniformity between federal and state exemptions in order to facilitate capital formation consistent with the...