Biggest Change for IPOs Still to Come - TheStreet

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TheStreet

-- Most years, the Fourth of July is simply a patriotic celebration. In 2013, however, it's a deadline.

Why? Because this year it's the last day that, according to the Jumpstart Our Business Startups Act (aka the JOBS Act), the Securities and Exchange Commission has to deliver new rules dealing with advertising for initial public offerings.

The changes, which are part of

Rule 506 of Regulation D

, are about to blow the lid off of offering advertisements. If you thought crowd funding would be the biggest change out of the JOBS Act, think again. It's Rule 506. The whole thing is hugely complicated and the SEC was given only 90 days to get it done.

"Staff are working hard to meet the Act's timetable," said John Nester, SEC spokesman. Good luck with that.

Companies using the Rule 506 exemption don't have to register their securities and don't have to file reports with the SEC. They file a Form D with minimal information. That's the appeal for many companies. They can sell to an unlimited number of "accredited investors" but until now, they couldn't advertise the securities. Also, the securities are restricted and can't be sold for a year.

Congress has decided to lift the prohibition on advertising, so the SEC has to decide how that advertising will work. Is a tombstone ad the limit? Or can companies set up websites to talk up the new offering? What about TV ads? Securities and advertising are like oil and water. They don't mix. But somehow the SEC will now have to blend these two and still manage to protect the unsuspecting investor.

The only caveat on the advertising is that all the investors must be accredited. This usually means the investor must have a net worth of $1 million and income in excess of $200,000 per year for an individual and $5 million for a business set up to acquire the investment. The SEC has to write rules around the verification of these accredited investors.

Back in the good old days of brokerages, you knew if your client had this net worth, now who knows? What if the client says their home in Florida is worth $500k, when in fact it isn't? Or what if they value Grandma's jewels at $1 million when they aren't? How can this be checked online? It can't. So somehow, the SEC has to figure out the parameters around ads and then also figure out a way to make sure the ads are seen by the appropriate people.

Here's an example of how hard this will be. I want to sell shares in DCB Corporation under Rule 506 and I set up a website to find investors. Can't I just create a click-through page? Like alcohol sites that verify you are over 21 to enter? I can just ask if the potential investor is accredited, if so click "Yes."

You may wonder how I could do this if I'm not a licensed securities broker (Full disclosure: my license expired in 2008). Well, another change in Rule 506 is that the JOBS Act will now allow non-licensed businesses to sell these offerings and Internet businesses can provide lists of these offerings. How did the brokerages let this slip through?

These companies can also set up platforms to trade these securities since they aren't normally listed on an exchange. No wonder companies like

Second Market

were so active in working for passage of the JOBS Act. This could be huge for their business, especially now that they no longer have Facebook shares to trade.

And yes, the SEC has to figure out how this will work too. They have to write regulations around platforms or mechanisms used for selling and offering the securities as well as rules around the Internet companies that can provide lists of these securities (presumably for a fee.) Congress gave them 90 days to figure all this out and made July 4th the deadline.

Well, they didn't meet the deadlines for Dodd-Frank, so no one in the market is really expecting that new rules will arrive next week. So far, the SEC has received more than 30 advance comment letters regarding the subject. Once the rules are actually proposed, then the SEC opens up for another comment period. This is not a quick process.

What you can expect from all this is that, in addition to all the pop-up crowd funding web sites, we will be flooded with sites set up to find accredited investors and trade these products. There will also be a tsunami of sites that will provide lists of these securities for a nominal subscription price. Advertisers will have a new source of income and financial news organizations will have new advertisers.

Crowd funding may have seemed like the biggest change from the JOBS Act for IPOs, but once you dig deeper -- it's Rule 506 that will really turn the market upside down.

--

Written by Debra Borchardt in New York

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.