BILL ANALYSIS �
AB 2081
Page 1
Date of Hearing: April 26, 2012
ASSEMBLY COMMITTEE ON BANKING AND FINANCE
Mike Eng, Chair
AB 2081 (Allen) - As Amended: April 11, 2012
SUBJECT : Securities transactions: qualification requirements:
exemptions.
SUMMARY : Provides that an issuer can offer or sell securities
using any form of general solicitation or general advertising.
Specifically, this bill :
1)Prohibits unsolicited telephone calls to a person's residence or
cellular telephone unless the issuer and the caller reasonably
believes after reasonable inquiry, prior to the unsolicited
telephone call, that the person is an accredited investor.
2)Provides that the sales of securities shall be made only to a
person who is or whom the issuer reasonably believes after
reasonable inquiry to be an accredited investor immediately
prior to the sale.
3)Provides that the issuer must show that the offering is suitable
for the person based on the person's financial status,
objectives, investment experience, time horizon, risk tolerance
and any other information the issuer deems relevant. The
information showing suitability must be kept for four years.
4)Establishes if a person is a natural person, the amount of
consideration paid by the purchaser does not exceed 10% of his
or her net worth.
5)Defines "net worth" as the terms used in the definition of an
accredited investor described below.
6)Allows the issuer to assume that the person has the capacity to
protect his or her interests in connection with the offering due
to his or her business or financial experience or the business
or financial experience of his or her professional adviser.
7)Requires the issuer to specify in all advertisements,
communications, sales literature or other information that is
publicly disseminated in connection with the offering, that the
securities will be sold to accredited investors only.
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8)Requires the issuer to believe in good faith that the offer and
sale are exempt from registration under Section 5 of the
Securities Act of 1933.
9)Defines "publicly disseminated" as communicated to 100 or more
persons or otherwise communicated, used, or circulated in a
public manner.
10)Requires a legend to be on the cover page of each disclosure
document advising that the securities described in the
disclosure document or subscription agreement will be sold to
accredited investors only.
11)Provides that dissemination of information regarding the
proposed offering to a person who is not an accredited investor
shall not disqualify the offering from exemption under this
subdivision.
12)Requires the issuer to file with Commissioner of the Department
of Corporations (DOC) a notice and pay the fee within 15 days
after the first sale of the securities in this state.
13)Prohibits the offering by an issuer who is an investment
company or a development stage company.
14)Provides that a person who purchases securities in an offering
that fails to meet all of the terms of this bill can bring
action for recession of the purchase. Also provides for
attorney's fees and costs to a prevailing purchaser in any such
action.
15)Prohibits the exemption:
a) If within five years immediately prior the first offer of
the security the person has filed a registration statement
that is the subject of a currently effective stop order
entered by any state securities administrator or the
Securities and Exchange Commission;
b) If within five years immediately prior to the first offer
of the security the person has been convicted of any criminal
offense involving fraud, deceit, or any offense concerning
the offer, purchase, or sale of any security;
c) If the person is subject to a state or federal
administrative enforcement order or judgment entered within
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the five years immediately prior to the first offer of the
security finding fraud or deceit in connection with the
purchase or sale of any security; or,
d) If the person is subject to any order, judgment or decree
of any court of competent jurisdiction.
16)Provides that the issuer has the opportunity to clear
themselves of a-d listed above.
EXISTING FEDERAL LAW:
1)Establishes the Securities Act of 1933 and the Securities and
Exchange Act of 1934 administered by the Securities and Exchange
Commission.
2)Establishes the National Association of Security Dealers that
helps define the national behavior standards for member and
minimum standards for listed securities which is regulated by
the Securities and Exchange Commission.
3)Prohibits, Except as provided in Rule 504(b)(1), neither the
issuer nor any person acting on its behalf shall offer or sell
the securities by any form of general solicitation or general
advertising, including, but not limited to, the following:
a) Any advertisement, article, notice or other communication
published in any newspaper, magazine, or similar media or
broadcast over television or radio; and
b) Any seminar or meeting whose attendees have been invited
by any general solicitation or general advertising. �Rule
502(c) of Regulation D]
4)Defines an "accredited investor" as any person who comes within
any of the following categories, or who the issuer reasonably
believes comes within any of the following categories, at the
time of the sale of the securities to that person:
a) Any bank or any savings and loan association or other
institution whether acting in its individual or fiduciary
capacity; any broker or dealer registered pursuant to section
15 of the Securities Exchange Act of 1934; any insurance
company, any investment company registered under the
Investment Company Act of 1940 or a business development
company, any Small Business Investment Company licensed by
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the U.S. Small Business Administration, any plan established
and maintained by a state, its political subdivisions, or any
agency or instrumentality of a state or its political
subdivisions, for the benefit of its employees, if such plan
has total assets in excess of $5,000,000; any employee
benefit plan within the meaning of the Employee Retirement
Income Security Act of 1974 if the investment decision is
made by a plan fiduciary, as defined in section 3(21) of such
act, which is either a bank, savings and loan association,
insurance company, or registered investment adviser, or if
the employee benefit plan has total assets in excess of
$5,000,000 or, if a self-directed plan, with investment
decisions made solely by persons that are accredited
investors;
b) Any private business development company;
c) Any organization described in section 501(c)(3) of the
Internal Revenue Code, corporation, Massachusetts or similar
business trust, or partnership, not formed for the specific
purpose of acquiring the securities offered, with total
assets in excess of $5,000,000;
d) Any director, executive officer, or general partner of the
issuer of the securities being offered or sold, or any
director, executive officer, or general partner of a general
partner of that issuer ;
e) Any natural person whose individual net worth, or joint
net worth with that person's spouse, at the time of his
purchase exceeds $1,000,000;
f) Any natural person who had an individual income in excess
of $200,000 in each of the two most recent years or joint
income with that person's spouse in excess of $300,000 in
each of those years and has a reasonable expectation of
reaching the same income level in the current year;
g) Any trust, with total assets in excess of $5,000,000, not
formed for the specific purpose of acquiring the securities
offered, whose purchase is directed by a sophisticated
person, and;
h) Any entity in which all of the equity owners are
accredited investors. �17 C.F.R. 230.501] �Rule 501,
Regulation D]
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EXISTING STATE LAW
1)Establishes the Corporate Securities Law of 1968 provides for
exemptions from qualification for certain securities
transactions. �Corporations Code, commencing with Section 25000]
2)Provides that the Commissioner of the DOC to approve all
securities offered or sold in California. �Corporation Code,
Section 25100]
3)Prohibits any person to offer or sell in this state any security
in an issuer transaction whether or not by or through
underwriters, unless such sale has been qualified under Section
25111, 25112 or 25113 or unless such security or transaction is
exempted or not subject to qualification. The offer or sale of
such a security in a manner that varies or differs from, exceeds
the scope of, or fails to conform with either a material term or
material condition of qualification of the offering as set forth
in the permit or qualification order, or a material
representation as to the manner of offering which is set forth
in the application for qualification, shall be an unqualified
offer or sale. �Corporations Code, Section 25110]
4)Requires all purchasers to have either have a preexisting
personal or business relationship with the offeror or any of its
partners, officers, directors or controlling persons, or
managers (as appointed or elected by the members) if the offeror
is a limited liability company, or by reason of their business
or financial experience or the business or financial experience
of their professional advisers who are unaffiliated with and who
are not compensated by the issuer or any affiliate or selling
agent of the issuer, directly or indirectly, could be reasonably
assumed to have the capacity to protect their own interests in
connection with the transaction.
�Corporations Code, Section 25102 (f)]
5)Defines "issuer" as any person who issues or proposes to issue
any security, except that:
a) With respect to certificates of deposit, voting trust
certificates or collateral-trust certificates, or with
respect to certificates of interest or shares in an
unincorporated investment trust not having a board of
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directors or persons performing similar functions or of the
fixed, restricted management or unit type, "issuer" means the
person or persons performing the acts and assuming the duties
of depositor or manager pursuant to the provisions of the
trust or other agreement or instrument under which the
security is issued. However, with respect to equipment-trust
certificates or like securities, "issuer" means the person by
whom the equipment or property is or is to be used.
b) With respect to certificates of interest or participation
in oil, gas or mining titles or leases or in payments out of
production under those titles or leases, "issuer" means the
person or persons in active control of the exploration or
development of the property who sell those interests or
participations or payments or any person or persons who
subdivide and sell those interests or participations or
payments. The determination of the person or persons in
active control of the exploration or development of the
property shall be made on the basis of the actual
relationship of the parties and not on the basis of the legal
designation of a person's interest.
c) With respect to a fractional or pooled interest in a
viatical or life settlement contract, "issuer" means the
person who creates, for the purposes of sale, the fractional
or pooled interest. In the case of a viatical or life
settlement contract that is not fractionalized or pooled,
"issuer" means the person effecting the transactions with the
investors in those contracts.
d) In the case of an unincorporated association which
provides by its articles for limited liability of any or all
of its members, or in the case of a trust, committee, or
other legal entity, the trustees or members thereof shall not
be individually liable as issuers of any security issued by
the association, trust, committee, or other legal entity.
�Corporations Code, Section 25010]
FISCAL EFFECT : Unknown.
COMMENTS :
Currently, small businesses may be constrained from finding other
sources of capitol because of the requirement that issuers have a
pre-existing relationship. This measure attempts to expand
opportunities for small businesses by allowing them to use forms
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of general solicitation or general advertising. General
solicitation would allow issuers to reach out to the "public" if
an issuer reasonably believes that the person is an accredited
investor. An issuer could use means of advertising through the
telephone or internet. While the original goal of this measure
may have been well intended by attempting to increase capital for
small businesses, the goal has been met at the federal level which
makes this measure no longer necessary.
THE JOBS ACT- GENERAL SOLICITATION & GENERAL ADVERTISING
On April 5, 2012, President Obama signed landmark legislation,
H.R. 3606, the Jumpstart Our Business Startups Act (the "JOBS
Act"). The JOBS Act makes it easier for startups and small
businesses to raise funds. This legislation passed Congress
through a 73-26 Senate vote and a 380-41 House vote. While the
JOBS Act makes various changes, the most important as to the
relation of this bill is allowing for general solicitation and
general advertising. The passage of this legislation makes AB
2081 unnecessary and duplicative to actions taken at the Federal
level. While the SEC does have 90 days from April 5, to change
its rules, this would also deem this measure premature considering
the finality of the Rules are not in print yet. It is clear with
the passage of the JOBS Act that general solicitation and general
advertising will be permitted.
Private investment funds generally rely on Rule 506 under
Regulation D to issue their securities in the United States
without being required to register the securities under the
Securities Act. Rule 506 permits a private fund to raise virtually
unlimited amounts of U.S. domestic capital so long as the
investors are all accredited investors. However, private
investment funds and their sponsors still have to find a way to
reach accredited investors. Prior to the JOBS Act, Issuers relying
on Rule 506 have been prohibited by Rule 502(c) from engaging in
any form of "general solicitation or advertising" to attract
investors. The SEC has never precisely specified what constitutes
a "general solicitation," although a number of no action letters
have set out guidance on the "manner of offering" restrictions of
Rule 502(c). Issuers have often been cautioned that to avoid a
general solicitation, an issuer must approach only offerees with
whom the issuer has a "preexisting substantive relationship."
Over the last several years, many commentators have noted the
deleterious effects on private investment funds' capital raising
created both by this "general solicitation" limitation and by the
vagueness and apparent internal contradiction in its
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interpretation.
Title II of the JOBS Act amends Section 4 of the Securities Act to
state specifically that a Rule 506 private placement shall not be
deemed a public offering solely as a result of general
solicitation or general advertising. It also orders the SEC to
modify Rule 506 within 90 days of enactment of the JOBS Act to
eliminate its prohibition against general solicitation or general
advertising for offers and sales of securities so long as all
purchasers of the relevant securities are accredited investors.
The Model Accredited Investor Exemption
The North American Securities Administrators Association (NASAA),
the association of state securities regulators, drafted and
approved a "Model Accredited Investor Exemption" during its 1997
Spring Conference. When adopted by individual states, the Model
Exemption provides a new exemption from registration of securities
at the state level for small companies that offer and sell their
securities exclusively to "accredited investors." The Model
Exemption is based on the premise that accredited investors are
capable of undertaking their own due diligence and gauging the
risk factors before making any investments in small companies.
California adopted a version of the Model Accredited Investor
Exemption in 1997. California, at that time, decided to not
explicitly allow for general solicitation and general advertising.
The model itself also did not explicitly use the terminology of
"general solicitation and general advertising."
FEDERAL ACITIVITY
The SEC established the Advisory Committee on Small and Emerging
Companies (ACSEC) 2011 to seek advice on its rules, regulations
and policies, as they relate to emerging companies or
privately-held small businesses and publicly traded companies with
less than $250 million in public market capitalization in the
areas of:
1)Raising capital through securities offerings, including private
and limited offerings and initial and other public offerings;
2)Trading in the securities of emerging and smaller public
companies; and
3)Public reporting and corporate governance requirements of
emerging and smaller public companies.
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On January 6, 2012, ACSEC made its first recommendation: "that the
SEC take immediate action to relax or modify the restrictions on
general solicitation and general advertising to permit general
solicitation and general advertising in private offerings of
securities under Rule 506 where securities are sold only to
accredited investors." The ACSEC also stated that is their view
that those investor protections afforded by the existing
restrictions on general solicitation and general advertising are
not necessary in private offerings of securities whereby the
securities are sold solely to accredited investors.
In November of 2011, the House passed the "Access to Capital for
Job Creators Act" (H.R. 2940) by a large and bi-partisan majority
of 413-11. If the bill becomes law, the Securities and Exchange
Commission (SEC) would be required within 90 days to revise Rule
506 of Regulation D to permit general solicitation and general
advertising for a private offering, as long as all purchasers are
accredited investors. Rule 506, which contains no limits on
offering size, is the most widely relied upon rule used for
private offerings that are exempt from registration under Section
4(2) of the Securities Act.
NEED FOR THE BILL :
According to the Author, "AB 2081 is needed to effectively reverse
its severe economic and unemployment downturns, it is imperative
that the state takes serious measures, such as enacting AB 2081,
that will facilitate access to capital for the small business
community so that they can obtain the capital to expand, provide
jobs and restart our economy. AB 2081 is designed to allow
start-up and emerging growth companies to find sophisticated
affluent investors who can provide the fuel for start-ups that
have the capacity to grow fast and create jobs, and to develop
innovative new technologies that will make our state more
competitive in the global economy."
CONCERNS
The Consumer Attorneys of California have concerns with AB 2081.
Their concerns "stem from the foreseeable consequences of misuse
of the proposed exemption. We believe the bill could benefit from
a closer look at foreseeable consequences including harm to
seniors who qualify as "accredited investors" based on their
assets but do not have the financial sophistication to protect
their life savings.
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Elderly retirees make up a disproportionately large percentage of
people who meet the definition of accredited investors simply
because their houses have had longer to appreciate, their savings
have had longer to accumulate, they may have taken lump-sum
payouts on their pensions and, sadly, many are widowed and hold
the proceeds of their spouses' life insurance policies. The funds
they stand to lose cannot be replaced. We think a closer look at
this issue warrants attention."
QUESTIONS:
1)In light of the massive changes to federal law from the JOBS Act
that permits general solicitation and general advertising, why
is this bill necessary?
2)While the SEC does have 90 days from enactment of the JOBS Act
to change its rules, why would the legislature want to move a
bill forward that may differ/counter from federal law? Would it
be better to wait and see the final changes and then make
changes if necessary?
3)The DOC is going to have to digest all the changes in the JOBS
Act and implement them at the state level, is it necessary to
also burden the DOC with another level of changes that may not
be necessary and then have DOC determine whether or not AB 2081
is preempted?
4)What is the goal of this measure? If the goal of this measure
is to allow for general solicitation and general advertising,
wasn't this goal met through the JOBS Act? If federal rule 506
now permits general solicitation and general advertising under
the JOBS act, why does California need a competing statute in
place?
5)This measure has the potential to confuse California Companies
and if anything companies will choose less restrictive statutes,
so won't California companies use federal rule 506 exemption to
get around the provisions in AB 2081?
DEVELOPMENTS SINCE THE LAST HEARING
On Monday, April 23, the Assembly Banking and Finance Committee
heard AB 2081. This measure failed passage. During that hearing,
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the point was made that this measure is unnecessary and may raise
additional concerns regarding competing regulations when
ultimately federal rule 506 preempts state law. It needs to be
clear that on April 5 of this year, President Obama signed the
JOBS Act; this is not a matter that is undecided or still being
worked on at the federal level. It is now law, and the SEC is
mandated to permit general solicitation and general advertising.
The goal of AB 2081 is to allow for general solicitation and
general advertising. Because of this recent change, it is not
necessary for California to have its own statute in place. The
legislature may want to make conforming changes once the rules are
final. The SEC has 90 days to make changes but the matter of
whether or not general solicitation and general advertising will
be permitted is not a question. It should also be noted, the JOBS
Act is a huge undertaking for the SEC and it has been stated that
on top of what the SEC is mandated to do, they may make additional
changes to provide for more protections. Also, while AB 2081 may
have more protections right now than the JOBS Act, the need for
the bill becomes more unclear because then California companies
will use the federal rule 506 exemption to get around California
law since rule 506 preempts state law. This creates a potential
for California Companies to go regulation shopping in order to
seek compliance with the least stringent regulatory framework.
RELATED LEGISLATION:
SB 978 (Vargas & Price) (2012 Legislative Session) makes several
changes including requiring the commissioner to require the issuer
to file a notice of transactions. The failure to file the notice
or the failure to file the notice within the time specified by the
rule of the commissioner shall not affect the availability of the
exemption. Any issuer that fails to file the notice as provided by
rule of the commissioner shall, within 15 business days after
discovery of the failure to file the notice or after demand by the
commissioner, whichever occurs first, file the notice and pay to
the commissioner a fee equal to the fee payable had the
transaction been qualified under Section 25110. Neither the filing
of the notice nor the failure by the commissioner to comment
thereon precludes the commissioner from taking any action that the
commissioner deems necessary or appropriate under this division
with respect to the offer and sale of the securities.
PREVIOUS LEGISLATION:
SB 875 (Price) (2010 Legislative Session) would have exempted
from qualification offerings or sales of securities using a
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general solicitation or general advertising, provided the
transaction meets specified requirements, including a requirement
that the sales are made to accredited investors. Senate Banking
and Financial Institutions, not set for hearing.
AB 1644 (Campbell & Briggs) (2001 Legislative Session) would have
exempted from qualification offerings or sales of securities using
a general solicitation or general advertising, provided the
transaction meets specified requirements, including a requirement
that the sales are made to accredited investors. Failed passage
in Assembly Banking and Finance Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
Small Business California (Sponsor)
California Association of Microenterprise Opportunity (CAMEO)
Opposition
AARP
Concerns
Consumer Attorneys of California
The Public Investors Arbitration Bar Association (PIABA)
Analysis Prepared by : Kathleen O'Malley / B. & F. / (916)
319-3081