As mandated by Congress pursuant to Section 201 of the Jumpstart our Business Startups Act (“JOBS Act”), the Securities and Exchange Commission (“SEC”) recently released its proposed rules to eliminate the prohibition against general solicitation and advertising in connection with offerings and sales pursuant to Rule 506 under Regulation D of the Securities Act. The removal of the general solicitation and advertising ban is conditioned upon issuers taking “reasonable steps” to ensure that only accredited investors participate in the underlying offerings. As always, the devil is in the details: Defining precisely what entails such reasonable steps was the brunt of the directive tasked of the SEC. By effectively punting its primary directive, the SEC appears to have opened the door to Congress reframing the scope of the mandate entirely.
As previously discussed, the SEC failed to provide firm guidance regarding the steps an issuer must take to ensure an investor is accredited. Instead, the SEC vaguely notes in its proposed release that issuers are to consider the facts and circumstances of the transactions, rationalizing that adopting specific verification methods “would be impractical and potentially ineffective in light of the numerous ways in which a purchaser can qualify as an accredited investor.” The SEC further notes that proposing such methods could be overly burdensome in some cases and ineffective in others.
In response, Senator Carl Levin (D-MI) sent a terse letter to the SEC, reprimanding the SEC for drafting a proposed rule that “provides no certainty to issuers and fails to establish methods sufficient to ensure that only accredited investors participate in the offerings.” He further notes that it was made clear that “self-certification” of accredited investors is inadequate, suggesting that the SEC’s proposed rules need to require common-sense documentation and/or verification practices and procedures.
Of potentially greater consequence to the hedge fund community, however, is Senator Levin’s surprising pivot at the close of the letter, in which he insists that the SEC not only failed to meet its statutory directive, but also misconstrued the scope of the mandate in applying it to private investment vehicles. In relevant part:
Congress did not contemplate removing the general solicitation ban – without retaining any limitations on forms of solicitation – for private investment vehicles. Indeed, no argument was made during the debate of the bill that the objective was to ease the capital aggregation process for private investment vehicles. The words “hedge fund,” “private fund,” or “investment vehicle” were not used either during the committee or floor debate in the House of Representatives. Nor did the Senate engage in any debate relating to removing these advertising and marketing restrictions completely from private investment vehicles.
Distinguishing between operational businesses and private investment vehicles in the context of removing the general solicitation ban would mark a major shift in tone and direction, potentially reframing and limiting the reach of the JOBS Act within the hedge fund community. If Senator Levin’s interpretation is carried through and adopted by the SEC in its final rules, fund managers may not be granted the broad array of capital raising options that, just a few weeks ago, appeared imminent.
We will continue to monitor the situation closely as we await the SEC’s final rules. Please feel free to contact us if you have any questions regarding the status of the JOBS Act or its potential impact on hedge fund marketing activities.