Private Investment Funds now face a more relaxed environment in their fund raising campaigns, as the Securities Exchange Commission (“SEC”) looks set to implement a rule that will allow the firms to attract more accredited investors by collecting some critical information about them. However, it is quite perplexing as to what change this rule brings to an environment that already allows hedge funds to advertise, and allows accredited investors to acquire stakes in the firms.
According to a report published on Harvard Law School’s Forum for Corporate Governance and Financial Regulation by Alan Klein, who is a partner in the Corporate Department at Simpson Thacher & Bartlett LLP, this is one of the capital reforms, run under the flagship of the Jumpstart Our Business Startups Act, alias (“JOBS Act”), enacted by the U.S Congress back in April, and proposed in late August.
The Proposed New Rule
The proposed rule in the JOBS Act, allows private investment firms (such as hedge funds) to use both general solicitations and general advertising to offer its securities. The current scenario also allows the firm to do so to accredited investors, which then begs the question, what’s the change? It is also said that the new rule will put some high threshold for the investment fund’s accredited investors, requiring the firm to comply with all before it can be allowed to use the general solicitation, or general advertising.
The threshold includes a verification process of the accredited investors’ status by assessing the investors based on the following key areas.
- The nature of the purchaser and the type of accredited investor that the purchaser claims to be
- The amount and type of information that the issuer has about the purchaser
- The nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering and the terms of the offering, such as a minimum investment amount
The process could also require the firm to inquire from third party databases, in order to verify some critical information about the prospective investors, such as review of W-2 or other tax forms, and receipt of letters from accountants or broker dealers.
In clarifying the proposed rule, the SEC took a case example of a situation, whereby an investment fund solicits its investors through public media, for instance a website or email marketings, pointing that such an issuer would have breached the new rule for failing to take appropriate measures in determining whether the investors are accredited or not.
However, the SEC made an objection to this scenario, taking an example of when the required minimum investment is a high figure, saying, “it may be reasonable for the issuer to take no steps to verify accredited investor status other than to confirm that the purchaser’s cash investment is not being financed by the issuer, or by a third party, absent any facts to the contrary.”
Additionally, the SEC expressly stated that it would be important for the issuer to retain sufficient records of documentation of the verification process, detailing the steps taken to verify that all its purchasers are accredited investors, notes the report.
Nonetheless, the proposed rule on verification, importantly, does not override what is termed as “reasonable belief” standard of an accredited investor, as stated in rule 501, which states that, “If an issuer takes reasonable steps to verify that a purchaser is accredited, and therefore reasonably believes the purchaser is accredited, the exemption will not be lost because the purchaser is not in fact accredited.”
Importantly, the issuing firm is required to inform the SEC of its intentions to use the general solicitation and general adversing while issuing securities, by disclosing in its Form 3D filing, which would give the firm an option of checking a separate box to be added to the form as part of the implementation of the rule.
Some Specifics From Existing Rules Remain Intact and Active
The proposed rule is not expected to change much in the current rule, as a majority of its defining key-points, such as accredited investors, are not expected to change; the definition still stands. Additionally, the current situation still remains, that is, investment firms can still offer securities to investors without general solicitations or general advertising. Furthermore, there will be no limitation on what is categorized as general solicitation and or general advertisng.
Finally, the rule also proposes that any sponsors of investment firms that wish to participate general solicitation and general advertising under the proposed rule, should note that that kind of communication would be subject to the anti-fraud provisions of the federal securities laws (including Rule 10b-5 under the Securities Exchange Act of 1934, among other rules.
However, in regards to IPOs, the JOBs Act raises serious concerns, as we point out in our article about Manchester United PLC (NYSE: MANU)’s decision to list on the NYSE Euronext (NYSE:NYX).