By Ron S. Geffner, Partner, Head of Financial Services, Sadis & Goldberg LLP
On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act, H.R. 3606 (“JOBS Act“). The JOBS Act requires the Securities & Exchange Commission (“SEC“) to revise existing rules to implement many of the provisions of the JOBS Act. This article provides a brief overview of the key changes to the securities laws effectuated by the JOBS Act, which we expect will affect alternative investment vehicles, such as hedge funds, private equity funds and fund of funds (collectively, “Private Funds“).
Overview of the JOBS Act
The JOBS Act will, among other things: (i) eliminate the prohibition against general solicitation and general advertising in connection with private offerings to accredited investors conducted in reliance on Rule 506 of Regulation D promulgated under the Securities Act of 1933, as amended (“Securities Act“); and (ii) increase the threshold number of investors for most issuers in connection with registration requirements under the Securities Exchange Act of 1934, as amended (“Exchange Act“), from 500 to (a) 2,000 or (b) 500 non-accredited investor “holders of record.” Click for a full copy of the JOBS Act.
General Solicitation and General Advertising For Private Funds
Most Private Funds conduct their offerings in reliance upon the following exemptions from registration: (i) Rule 506 of Regulation D under the Securities Act; and (ii) either Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940, as amended (“Investment Company Act“). Under the Securities Act, any offer to sell securities must either be registered with the SEC or meet an exemption. Rule 506 of Regulation D of the Securities Act provides exemptions from the registration requirements, allowing Private Funds to offer and sell their securities without having to register the securities with the SEC.
Rule 502(c) of Regulation D prohibits a Private Fund from engaging in any form of general solicitation or general advertising. While current rules do not define “general solicitation” or “general advertising,” Rule 502(c) broadly states that these may include, but are not limited to, “any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.” Pursuant to Regulation D, Private Funds have been prohibited from advertising or contacting potential investors with whom the manager of the fund or a placement agent did not have a pre-existing relationship. While Regulation D prohibits a Private Fund from engaging in a general solicitation, Sections 3(c)(1) and 3(c)(7) prohibit a Private Fund from making a public offering.
The JOBS Act is ultimately expected to allow a Private Fund relying on Regulation D and Sections 3(c)(1) or 3(c)(7) under the Investment Company Act, pursuant to certain conditions, to engage in general solicitation and general advertising. Section 201(b)(2) of the JOBS Act provides that transactions conducted pursuant to Rule 506 “shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation.” The SEC has previously provided that offerings that comply with Rule 506 do not constitute a public offering for purposes of Sections 3(c)(1) or 3(c)(7) of the Investment Company Act. Section 201 of the JOBS Act requires the SEC, no later than 90 days after the JOBS Act was signed by the President, to eliminate the prohibition against general solicitation and general advertising in connection with Rule 506 offerings; provided that the securities are sold solely to accredited investors. Until the SEC amends existing regulations, the general solicitation and general advertising prohibitions continue to remain in effect.
Registration Triggers Under Section 12(g) of the Exchange Act.
Section 12(g)(1) of the Exchange Act currently requires an issuer that has a class of equity securities held of record by 500 or more persons to register that class with the SEC within 120 days after the last day of the first fiscal year in which the issuer had total assets exceeding $10,000,000. In general, the JOBS Act increases the threshold for registration under the Exchange Act for becoming a public reporting company from 500 or more record holders to (a) 2,000 or more record holders or (b) 500 or more recordholders who are not accredited investors. Subject to the specific exceptions, the JOBS Act does not change the SEC’s current method for determining the number of “record holders” under Section 12(g).
The JOBS Act will affect the distribution of Private Funds in the United States. However, it is too soon to predict the extent of its impact on the alternative investment industry. We expect that these changes will enhance the ability of managers of smaller Private Funds who have been managing or operating their businesses at a competitive disadvantage against managers of larger funds with mature distribution channels or investor relations teams. Further, we expect that managers of Private Funds of all sizes will be more vocal with the media than in the past, as many managers of Private Funds have been hesitant about speaking publicly in connection with the fear of violating the prohibition against general solicitation. Nonetheless, we believe that there may still be significant restrictions against general solicitation and general advertisements. In particular, (i) while implementing the regulations of the JOBS Act, the SEC may further scrutinize and impose additional prohibitions in connection with advertisements regarding Private Funds under Section 206 of the Investment Advisers Act of 1940, as amended, an anti-fraud provision, and Rule 206(4)(1) promulgated thereunder; (ii) there may be inconsistencies with rules governing placement agents registered with the Financial Industry Regulatory Authority, engaged by Private Funds to assist in attracting investors’ assets; (iii) there may be inconsistencies with rules governing managers of Private Funds subject to the Commodity Futures Trading Commission and the National Futures Association regulations; and (iv) various state regulations (e.g., managers not registered as an investment adviser, blue sky laws) may still prohibit managers of Private Funds from engaging in general solicitation.
With regard to Section 12(g), we believe the JOBS Act will have minimal impact on the structuring of Private Funds since Section 3(c)(1) separately limits the number of investors in a Private Fund relying on such exemption to not more than 100 persons. While other Private Funds relying on Section 3(c)(7) may benefit, we have found few Private Funds having an issue with the previous 500-person threshold for Exchange Act registration.
With regard to timing, based upon our firm’s experience with SEC rulemaking, while we anticipate that the SEC may propose new rules within the required deadlines, we do not anticipate that final rules will be adopted until after the deadline. Prior to making use of any advertisements, Private Funds should confer with legal counsel to ensure compliance.
On March 27, 2012, the House of Representatives passed the JOBS Act by a 380-41 vote. The week prior, the Senate passed an identical version of the JOBS Act by a vote of 73-26.
See, e.g., STARS & STRIPES GNMA Funding Corp., SEC No-Action Letter (Apr. 17, 1986); see also Advisers Act Release No. 22597 (Apr. 3, 1997).
Ron S. Geffner is a member of the firm’s Executive Committee and also oversees the Financial Services Group. He regularly structures, organizes and counsels private investment vehicles, investment advisory organizations, broker-dealers, commodity pool operators and other investment fiduciaries. Mr. Geffner also routinely counsels clients in connection with regulatory investigations and actions. His broad background with federal and state securities laws and the rules, regulations and customary practices of the SEC, Financial Industry Regulatory Authority, Commodities Futures Trading Commission and various other regulatory bodies enables him to provide strategic guidance to a diverse clientele. He provides legal services to hundreds of hedge funds, private equity funds and venture capital funds organized in the United States and offshore. firstname.lastname@example.org
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