JOBS Act: Does Your Fund Have a Facebook Page?
The Jumpstart Our Business Startups Act (JOBS Act), which was signed into law on April 5, 2012, by President Obama, contains several provisions which may substantially broaden the fundraising methods available to private funds. The JOBS Act eases the regulatory framework for private offerings by (i) removing the prohibitions against general solicitation and general advertising for securities offerings exempt from registration under Rule 506 of Regulation D, so long as all purchasers of such securities are "accredited investors" and (ii) raising the equity holder of record threshold that triggers public reporting in Section 12(g) of the Securities and Exchange Act of 1934 (Exchange Act) from 500 persons to 2,000 persons, so long as the number of such equity holders who are not "accredited investors" does not exceed 499.
The elimination of the prohibition against general solicitation and general advertising will increase the ability of private funds to market their offerings through new channels, such as press releases, advertisements in financial or other publications, media interviews, publicly available websites and social media, and, consequently, increase the pool of prospective investors. It is important to note, however, that the current rules and restrictions with respect to general solicitation and general advertising are still in effect until the SEC takes action to amend Rule 506 of Regulation D as required by the JOBS Act. The JOBS Act directs the SEC to revise Rule 506 of Regulation D by July 4, 2012. Based on recent experience with SEC rulemaking in connection with the Dodd-Frank Act, it is certainly possible that the process will take longer. The increase to the equity holder of record threshold that triggers public reporting in Section 12(g) of the Exchange Act was effective as of April 5, 2012.
Although the JOBS Act, assuming no new rule making or other guidance to the contrary by the SEC, will provide new options to private funds raising capital, it is important for private funds to keep in mind the other restrictions that remain for private funds conducting U.S. private offerings that are unaffected by the JOBS Act. This alert summarizes the revisions mandated by the JOBS Act that directly impact private offerings by private funds as well as certain restrictions on private offerings by private funds that must be considered and complied with notwithstanding the JOBS Act.
JOBS Act Provisions Directly Affecting Private Offerings by Private Funds
Removal of General Solicitation Prohibition under Rule 506 of Regulation D. The JOBS Act directs the SEC to remove the prohibition against general solicitation and general advertising as applied to offers and sales of securities made pursuant to Rule 506 of Regulation D, so long as all purchasers of the securities are "accredited investors." The JOBS Act also directs the SEC to establish methods to be used by issuers to verify whether purchasers of securities are "accredited investors," and to require issuers to take reasonable steps using those methods to verify that the purchasers of securities in the offering are "accredited investors." Expect the SEC to propose and possibly adopt rules that go beyond a questionnaire or "check the box" process to verify accredited investor status.
Offerings Exempt Under Rule 506 Not Deemed "Public Offerings" Under Federal Securities Laws. The JOBS Act provides that offers and sales of securities that are exempt under Rule 506 of Regulation D will not be deemed "public offerings" under the federal securities laws as a result of general advertising or general solicitation. This amendment is relevant to private funds that rely on either Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940 (Investment Company Act) for exemption from registration under that statute because such exemptions prohibit funds from making a "public offering" of their securities. Thus, the JOBS Act is expected to allow a private fund relying on a 3(c)(1) or 3(c)(7) exemption to engage in general solicitation and general advertising. It is possible, however, that SEC rulemaking and guidance in the wake of the JOBS Act will specifically address the application of this provision to the term "public offering" in Sections 3(c)(1) and 3(c)(7).
Broker-Dealer Registration Exemption. The JOBS Act provides that, in connection with the offer and sale of securities in compliance with Rule 506, registration as a broker or dealer under the Exchange Act will not be required solely because a person (or such person’s associates):
operates data bases, websites or other platforms or mechanisms that
permit the offer, sale and purchase of securities or the negotiation of or with respect to securities, or
permit general solicitation and general advertising;
co-invests in the securities; or
provides ancillary services relating to the securities (such as due diligence or standardized documentation).
In each case, the exemption from registration is available only if such person and any associated person:
receive no compensation in connection with the purchase and sale of the securities,
do not have possession of customer funds or securities in connection with the purchase and sale of securities; and
are not otherwise subject to statutory disqualification.
Increase in Equity Holder Threshold for Public Reporting. The JOBS Act increases the limit (from 500 to 2,000) on the number of equity holders of record that an issuer may have before the issuer is required to register under Section 12(g) of the Exchange Act, so long as the number of equity holders of record that are not accredited investors does not exceed 499. This change is helpful to sponsors of private funds relying on the 3(c)(7) exemption under the Investment Company Act, particularly private funds that target high net worth individuals, because it allows them to organize funds with up to 2,000 "accredited investors."
Restrictions on Private Offerings by Private Funds Not Affected by the JOBS Act
Registration under the Investment Company Act.Although the JOBS Act provides that offers and sales of securities that are exempt under Rule 506 of Regulation D will not be deemed "public offerings" under the federal securities laws as a result of general advertising or general solicitation, the exception from the definition of "investment company" provided in Section 3(c)(1) of the Investment Company Act will continue to apply only to private funds whose outstanding securities are beneficially owned by 100 or fewer persons. If an investment fund exceeds 100 beneficial owners (whether it employs general solicitation and general advertising activities or not), it will need to find another available exception (such as the 3(c)(7) exemption if its investors satisfy the "qualified purchaser" suitability standard required for such exemption) or register under the Investment Company Act.
Registration under the Investment Advisers Act.The available exemptions from registration under the Investment Advisers Act of 1940 (Advisers Act) were not changed by the JOBS Act. As a result, an investment adviser that relies on an exemption from registration under the Advisers Act will need to consider the effect that any increases in the number of clients and investors and assets under management that may result from general solicitation and general advertising would have on the availability of such exemptions.
Anti-fraud Provisions. The anti-fraud provisions of the federal securities laws will continue to be applicable to all U.S. private placements notwithstanding the JOBS Act. The potential for increased litigation is certainly possible given the use of general solicitation and advertising by private funds and others seeking capital, especially from investors with whom there is no pre-existing relationship and track record. As a result, private funds that intend to engage in such activities should establish processes and procedures to ensure that all offering materials contain full and fair disclosure, are consistent with other disclosure documents which will be provided to potential investors and otherwise comply with applicable laws.
Broker/Dealer Registration.Under current law, a general partner, manager, fund sponsor or any other person that solicits investors on behalf of a private investment fund must register with the SEC as a broker or dealer unless an exemption from registration applies. As mentioned above, the JOBS Act provides for a new limited exemption to the broker-dealer registration requirements in connection with Rule 506 offerings, but that exemption is very narrow and will not be applicable in most circumstances given the nature of the restrictions. So even though general solicitation and general advertising in connection with Rule 506 offerings will be permitted, brokers and dealers that sell securities in those offerings will still be required to be registered unless another exemption from registration applies.
Registered Advisers and Members of FINRA.Private funds and their advisers must continue to consider and comply with the advertising and disclosure rules applicable toregistered investment advisers and FINRA members.
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.