The Jumpstart Our Business Startups Act or JOBS Act, intended to encourage funding of United States small businesses by easing various securities regulations, was signed into law by  President Obama on April 5, 2012.

By Louis A. Zambrio

On April 5, 2012, the Jumpstart Our Business Startups Act (“JOBS Act”) was signed into law. The fundamental change that it will have on companies is their ability to raise capital through a private placement under Rule 506 of Regulation D of the Securities Act of 1933, as amended (“Rule 506 Offering”). The JOBS Act, among other things, will eliminate the prohibitions under the U.S. federal securities laws against general advertising or general solicitation in connection with a Rule 506 Offering; provided that all purchases are made to accredited investors. The elimination of the general advertising and general solicitation restrictions could have a significant impact on a company’s ability to raise capital because it allows companies to reach a more diverse group and larger number of potential investors through their marketing efforts. The enactment of the JOBS Act directed the U.S. Securities and Exchange Commission (“SEC”) to revise Rule 506 of Regulation D within 90 days of its enactment, or by July 4, 2012. The current rules are still applicable to Rule 506 Offerings until the SEC amends Rule 506 of Regulation D.

Currently, under Rule 506 of Regulation D, companies are prohibited from soliciting investors through general advertisements or general solicitations, which makes it difficult for startups and small companies to raise capital since, as is often the case, they do not have enough contacts who are accredited investors that have the financial capability to invest in their company. With the implementation of the JOBS Act, a company will have the ability to tap a larger pool of investors than they originally had access to since they will now be allowed to solicit investors through general advertisements and general solicitations. This should open up access to more funding opportunities then companies previously experienced. The one caveat is that all investors must be accredited investors as such term is defined under Rule 501(a) of Regulation D (“Accredited Investor”).

An Accredited Investor is generally someone who has enough knowledge and business experience and acumen that they do not need to be afforded the full protection of the securities laws. Since this was a difficult standard to interpret, the SEC enacted Rule 501(a) to clarify the meaning of an Accredited Investor. There are eight (8) different categories of investors under the definition of an Accredited Investor, the most widely used by startup and small companies is:

  • 501(a)(6) any natural person whose individual net worth, or jointly with their spouse, exceeds $1 million at the time of purchase, excluding the value of such person’s primary residence; or
  • 501(a)(7) any natural person with income exceeding $200,000, or joint income with a spouse exceeding $300,000, for the two most recent years with a reasonable expectation of achieving the same income level in the current year.

A company can avail itself of the elimination of the advertising prohibitions in a Rule 506 Offering by taking “reasonable steps to verify that purchasers of the securities are accredited investors”. The meaning of this standard is unclear as of now, but hopes are that the SEC will clarify its meaning when it revises Rule 506 of Regulation D.

Once the SEC amends Rule 506 of Regulation D, companies will be able to conduct private placements through the facilitation of general advertisements and general solicitations as long as they reasonably verify that the securities are sold to Accredited Investors only.

New Laws Place Restrictions and Limits on After Sale Data Passes and Negative Option Marketing

On December 29, 2010, President Obama signed the “Restore Online Shoppers’ Confidence Act” into law. This new law places restrictions and limits on after sale “data passes” and “negative option” marketing through Internet sales.   Senator John D. (Jay) Rockfeller, IV Chairman of the U.S. Senate Committee on Commerce, Science, and Transportation originally introduced the Bill, ultimately becoming this law, in May after the Senate conducted hearings into the practices of Affinion, Vertrue, and Webloyalty cloud collaboration.  The Committee published information about the objectionable practices.  The New York Attorney General’s Office had also opened an investigation against these companies resulting in multi-million dollar settlements.

In a nutshell, these third-parties were offering various membership clubs to users of e-commerce sites. Typically, when a user of an e-commerce site completed an online purchase, that user would be re-directed to join a membership discount club for promotions, rebates, and the like. The user never had to re-enter his or her credit card, because the card information was passed off from the e-commerce site where the user just completed a transaction. Many users apparently did not understand that their credit cards would be charged, since they did not need to re-enter credit card data at the membership club registration. The clubs then typically offered a free trial period after which the user’s credit card would be charged if they did not cancel the membership. If not cancelled, the club operator placed recurring monthly charges to the user’s credit card. In general, the process of interpreting silence as acceptance or automatically charging the user unless they cancelled is a “negative option” sale.

The law prohibits an initial e-commerce vendor from passing-off a user’s credit card information to a third-party in a post-transaction sale for the purposes of that post-transaction third-party’s sale of goods or services to the user.

The law makes it unlawful for a post-transaction third-party seller to charge or attempt to charge a user’s credit or debit card, or bank or other financial account for an Internet sale, unless:

(1) before obtaining the consumer’s billing information, the post-transaction third party seller has clearly and conspicuously disclosed to the consumer all material terms of the transaction, including: (A) a description of the goods or services being offered; (B) the fact that the post-transaction third party seller is not affiliated with the initial merchant, which may include disclosure of the name of the post-transaction third party in a manner that clearly differentiates the post transaction third party seller from the initial merchant; and, (C) the cost of such goods or services; and, (2) the post-transaction third party seller has received the express informed consent for the charge from the consumer whose credit card, debit card, bank account, or other financial account will be charged by: (A) obtaining from the consumer— (i) the full account number of the account to be charged; and (ii) the consumer’s name and address and a means to contact the consumer; and (B) requiring the consumer to perform an additional affirmative action, such as clicking on a confirmation button or checking a box that indicates the consumer’s consent to be charged the amount disclosed.”

The law also makes “negative option” sales illegal unless the seller:

“(1) provides text that clearly and conspicuously discloses all material terms of the transaction before obtaining the consumer’s billing information; (2) obtains a consumer’s express informed consent before charging the consumer’s credit card, debit card, bank account, or other financial account for products or services through such transaction; and (3) provides simple mechanisms for a consumer to stop recurring charges from being placed on the consumer’s credit card, debit card, bank account, or other financial account.”

The law gives the Federal Trade Commission enforcement authority, and also allows state attorneys general to enforce the law, with the remedies and penalties available under the Federal Trade Commission Act.

There has been some confusion generated in online content about this law. Apparently, some are concerned that the law absolutely prevents any post-transaction up-selling, even if it were done by the first-party website where the user made the initial purchase.

However, the law defines a “post-transaction third party seller’’ as one who:

“(A) sells, or offers for sale, any good or service on the Internet; (B) solicits the purchase of such goods or services on the Internet through an initial merchant after the consumer has initiated a transaction with the initial merchant; and (C) is not: (i) the initial merchant; (ii) a subsidiary or corporate affiliate of the initial merchant; or (iii) a successor of an entity described in clause (i) or (ii).”

Thus, it seems fairly clear that an “initial merchant” is not prevented from post-transaction marketing, but is clearly prevented from passing the financial data allowing the charging of the user to another entity. Nevertheless, if e-commerce vendors are cross-selling through any non-subsidiary or corporate affiliate strategic alliances, they should ensure that data passes are not made, and the entity to which the user is referred complies with all transparency obligations. All should note the requirements on “negative option” sales.