Section 201(a)(1) of the JOBS Act directs the SEC to repeal the ban on general solicitation and general advertising in securities offerings under Rule 506 of Regulation D and Rule 144A. Can advertisements for hedge funds in Cigar Aficionado and The Wine Spectator be far behind?
Not so fast. The SEC has missed its July 4 deadline to adopt regulations to implement Section 201(a)(1). It recently scheduled an open meeting for August 22, 2012 to consider rules to eliminate the general solicitation and advertising prohibitions in private placement offerings.
But the devil is in the details. We have no indication whether the SEC will take an expansive or narrow approach to general solicitation and general advertising rules for private funds, or whether it will tackle the thorny issue of performance advertising by private funds at all in this round of rulemaking.
This appears to be yet another contentious issue for the SEC to address. Many believe that private funds should be able to advertise performance as part of a general solicitation, because, at the end of the day, only sophisticated investors may invest in those funds, thus mitigating the likelihood that the advertisements will mislead the average investor. Others, like the Investment Company Institute, have argued that the SEC should prohibit performance advertising by private funds until it adopts standards similar to those that apply to mutual funds. In particular, the ICI has urged the SEC to apply the performance advertising standards of Rule 482 under the Securities Act of 1933 to private funds.
The SEC Division of Investment Management’s dance card is already full, as it considers controversial regulations covering money market funds, use of derivatives and leverage by investment companies, and distribution fees. In light of the pending regulatory drama and the staff’s ballooning workload, we may not see new rules governing private fund performance advertising any time soon.
Performance advertising is not the only challenge relating to private funds that the SEC faces. The SEC’s rules must “require the issuer to take reasonable steps to verify” that investors are “accredited investors.” Private fund sponsors generally believe that the current rules do just that. A comment letter from a well-known hedge fund sponsor argued that Congress mandated the SEC only to establish a reasonable safe harbor for issuers to verify whether an issuer is accredited, and that an investor’s certification is a reasonable verification. Others, like William Galvin, the Massachusetts Secretary of the Commonwealth, disagree, calling for rules that require issuers to determine whether investors are accredited based on documentary evidence.
The SEC has an opportunity to address other issues of concern to private fund issuers. For example, although Section 201(b) clearly states that offerings that comply with Rule 506 shall not be deemed public offerings under federal securities laws, there is no comparable reference to a Rule 144A offering. The Committee on Federal Regulation of Securities of the American Bar Association’s Business law section suggested that the SEC should confirm that a general solicitation or general advertising by a private fund will not be a “public offering” for purposes of Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act.
Whatever the SEC does at its open meeting on August 22, 2012 regarding private fund offerings, the proposals are likely to generate passionate debate that may not be resolved any time soon.