|April 11, 2012|
Previously published on April 9, 2012
On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (the “JOBS Act”) into law. The JOBS Act will have a significant impact on the way that hedge funds, private equity funds and other private funds raise capital by, among other things, eliminating certain restrictions against general solicitation and general advertising and increasing the shareholder threshold required for reporting under the Exchange Act. The JOBS Act also enacts other reforms designed to reduce regulatory burdens on initial public offerings of emerging companies and offerings conducted under Rule 144A of the Securities Act.
Elimination of the Restriction on General Solicitation
The JOBS Act requires the SEC, within 90 days of its effectiveness (July 4, 2012), to eliminate the current restriction on “general solicitation and general advertising” in connection with offerings under Rule 506 of Regulation D, provided that all sales are made only to accredited investors. Most private funds rely on the safe harbor in Rule 506 to ensure that they are not engaged in a public offering of their securities (which would require registration under the Securities Act and the Investment Company Act).
To rely on Rule 506, a private fund is currently not permitted to use “any form of general solicitation or general advertising” when conducting an offering of its securities. This restriction generally prohibits, among other things, the use of publicly available websites, media broadcasts (such as radio and television advertisements), mass email campaigns, and/or public seminars or meetings. After the SEC revises its rules, this restriction will cease to apply to private funds relying on Rule 506 (and persons acting on their behalf).
SEC rules must require that a private fund take “reasonable steps” to verify that purchasers of its securities are accredited investors, using such methods as determined by the SEC. A common practice of many private funds is to have prospective investors complete qualification questionnaires indicating that they are accredited investors. It is unclear whether this practice will be sufficient to satisfy the “reasonable steps” requirement. Further, Rule 506 of Regulation D currently permits private funds to sell securities to up to 35 investors that do not qualify as accredited investors, provided certain conditions are met. We believe that private funds that engage in general solicitation or general advertising will not be able to accept investments from non-accredited investors.
Finally, the JOBS Act provides that offers and sales under Rule 506 “shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation.” Accordingly, it seems that private funds that rely on Section 3(c)(1) or 3(c)(7) of the Investment Company Act will be able to continue to rely on Section 3(c)(1) or 3(c)(7) while engaging in general advertising or general solicitation, although the SEC may determine otherwise in the rules it adopts to implement the JOBS Act. Further, it is not clear that the SEC will continue to view an adviser to a private fund that conducts an offering under Rule 506 via a general solicitation or general advertising as not holding itself out as an investment adviser, which is particularly important as a condition to taking advantage of the exemption for foreign private advisers.
In addition, many fund advisers currently rely on the exemptions from commodity pool operator registration in CFTC rules 4.13(a)(3) and 4.13(a)(4)1. These exemptions require that interests in each applicable fund “are offered and sold without marketing to the public in the United States.” Because the JOBS Act only applies to the “Federal securities laws,” it is unclear whether a fund adviser will be able to rely on these exemptions while engaging in general advertising or general solicitation. Also, fund advisers that are registered with the CFTC as commodity pool operators and/or commodity trading advisers will continue to be subject to the CFTC’s rules relating to advertising.
Note that the JOBS Act does not amend Regulation D to permit general advertising or general solicitation. Rather, the Act directs the SEC to amend its rules within 90 days. We recommend that private funds and persons acting on their behalf not engage in any general advertising or general solicitation until the SEC adopts final rules implementing the JOBS Act (even if the SEC only adopts rules after the deadline passes). Advisers that are registered with the SEC also must continue to comply with the Advisers Act’s rules relating to advertising.
Increased Threshold for Exchange Act Reporting
The JOBS Act significantly increases the number of investors that a private fund may have before it is required to file periodic reports under the Exchange Act. Section 12(g) of the Exchange Act currently requires reporting by an issuer that has more than $10 million in assets and a class of equity securities that is held of record by 500 or more persons (or, in the case of a non-U.S. issuer, held of record by 300 or more U.S. persons).
The JOBS Act increases this threshold by requiring periodic reporting only when an issuer has more than $10 million in assets and a class of securities that is held of record either by (i) 2,000 or more persons or (ii) 500 or more persons who are not accredited investors. In order to rely on the increased threshold, each record holder must be an accredited investor. If an issuer is not able to ascertain a record holder’s status, or each record holder is not accredited investor, such an issuer will be required to file periodic reports with the SEC upon having 500 holders of record. In each case, employees who received their securities pursuant to exempt transactions under employee compensation plans will not be counted as holders of record for purposes of these calculations.
1 The CFTC recently repealed CFTC rule 4.13(a)(4), effective Dec. 31, 2012. See http://www.bingham.com/Media.aspx?MediaID=13528.