On April 5, 2012, President Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. Hedge funds and their managers have followed the JOBS Act with interest and should note that the Act: (1) eliminates the ban on general solicitation and general advertising for sales of securities to accredited investors under Regulation D; (2) permits the sale of securities under Rule 144A to persons other than qualified institutional investors; and (3) increases the threshold for becoming a “reporting company” under Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”).
General Solicitation and Advertising Permitted in Certain Regulation D Offerings
Issuers undertaking private securities offerings under Regulation D have traditionally had only limited means to solicit and advertise their offerings, because of the long-standing prohibition against activity that could be construed as general solicitation or general advertising. Rule 506 has provided an exemption from registration requirements of Section 5 of the Securities Act of 1933 (the “Securities Act”) for the offer and sale of securities, such as hedge fund interests and private equity fund interests, so long as the sales were made primarily to accredited investors and the issuer did not market the securities via any “general solicitation or general advertising.” Under Rule 502(c), general advertising includes, “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.” The JOBS Act instructs the Securities and Exchange Commission (“SEC”) to amend Rule 506 of Regulation D to provide that the prohibition against general solicitation or general advertising does not apply to offers and sales of securities under Rule 506 of Regulation D where the securities are sold only to accredited investors. The JOBS Act further directs the SEC to require an issuer who relies on Rule 506 to take “reasonable steps” to verify that purchasers of the securities are accredited investors and to create methods by which issuers can verify an investor’s accredited status. The JOBS Act also amends Section 4(2) of the Securities Act of 1933 to provide that offers and sales under Rule 506 (as amended) will not be deemed to be public offerings under Federal securities laws as a result of general advertising or general solicitation activity. Removing the prohibitions on general solicitation and general advertising may be particularly advantageous to private funds and their managers, those relying on Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 (the “Investment Company Act”), because both exemptions prohibit funds from making a “public offering” of their securities. The JOBS Act should allow a private fund relying on either the 3(c)(1) or 3(c)(7) exemption to utilize general solicitations and general advertisements since the JOBS Act specifically provides that Rule 506 offerings that utilize general solicitations and general advertisements will not be deemed “public offerings”. However, SEC rulemaking may specifically address the application of this provision to the term “public offering” in Sections 3(c)(1) and 3(c)(7), and the specific impact on private funds and their managers will remain to be seen. So long as the SEC does not adopt rules restricting an otherwise clear mandate from Congress, we anticipate that the revised regulations will provide substantially greater flexibility to issuers conducting private offerings under Rule 506, including hedge funds, venture capital funds, private equity funds, commodity pools, and other private investment funds. We anticipate that private fund managers will be able to communicate information about fund offerings on publicly available websites and through press releases provided that the actual sales are made only to accredited investors.
General Solicitation and Advertising Permitted in Rule 144A Transactions
The JOBS Act also removes of the prohibition on general solicitation and general advertising for the resale of securities under Rule 144A. Rule 144A provides a safe harbor exemption from the registration requirements of Section 5 of the Securities Act for certain offers and sales of qualifying securities to “qualified institutional buyers” by certain persons other than the issuer of the securities. A person wishing to rely on Rule 144A in connection with the resale of securities has traditionally not been able to use means that might be considered general solicitation or general advertising to offer 144A securities. The JOBS Act directs the SEC to amend Rule 144A to provide that securities sold thereunder may be offered to persons other than qualified institutional buyers (“QIBs”), including through the use of general solicitation or general advertising, as long as the securities are sold only to persons whom the issuer “reasonably believes” to be QIBs. Any distinction between the “reasonable steps” standard under the Rule 506 amendment and the “reasonably believes” standard under the Rule 144A amendment, has been left to the SEC to decide.
Regulation A Offering Limit Extended to $50 Million
The JOBS Act mandates that the SEC create a new class of securities exempt from the registration requirements under the Securities Act. This new category of exempt securities will effectively increase the size of Regulation A offerings to cover sales of up to $50 million of exempt securities by a company in a 12-month period. Section 3(b) of the Securities Act gives the SEC authority to exempt certain securities from registration. Pursuant to this provision, the SEC adopted Regulation A to allow small companies to raise limited amounts of capital without going through the burdens of full registration. However, Regulation A, which only allowed issuers to raise a maximum of $5 million prior to the enactment of the JOBS Act, has been a relatively little-used exemption. Title IV of the JOBS Act is intended to increase the appeal of Regulation A. Companies seeking to take advantage of the new offering limit will still need to file annual audited financial statements and comply with any other periodic reporting requirements that the SEC may proscribe. The SEC is further instructed to review the maximum offering amount under Regulation A every two years, to consider whether increasing the maximum further would be appropriate. Securities offered pursuant to Regulation A will not be “restricted securities” and will be immediately and freely resalable to the public. Issuers may also “test the waters” and solicit interest prior to the offering by filing an offering statement. Regulation A securities may also be promoted through general solicitation and advertisement, expanding the potential pool of investors available to issuers. Finally, the securities offered through the extended Regulation A exemption will be “covered securities” under the National Securities Markets Improvement Act of 1996 (“NSMIA”) and thus will not be subject to state securities law review. In order to avoid state securities law review, the securities must be sold on a national exchange or sold to “qualified purchasers”.
Increase in Section 12(g) Trigger for Registration
The JOBS Act amended Section 12(g) of the Exchange Act to increase the trigger for registration of a class of equity securities to either 2,000 shareholders of record or 500 record holders who are not accredited investors. Section 12(g) has required a fund with more than $10 million in assets as of the last day of that fiscal year to register with the SEC and begin Exchange Act reporting if the fund had a class of equity securities with at least 500 shareholders of record. The increased threshold under the JOBS Act excludes shareholders who received their securities pursuant to an employee compensation plan, as part of the new crowdfunding exemption, or under the expanded Regulation A exemption. However, those private funds relying on the exclusion from the definition of “investment company” under Section 3(c)(1) of the Investment Company Act will still be limited to not more than 100 beneficial owners. The SEC will need to address how an issuer should verify whether an investor was, at the time of the person’s acquisition of the securities, an accredited investor and whether the person has subsequently lost that status. Also, the SEC will likely determine whether subsequent holders of securities that were originally issued pursuant to an employee compensation plan, the crowdfunding exemption, or the expanded Regulation A exemption count toward the threshold.
Implementation Timeline
The SEC has 90 days from enactment of the JOBS Act to amend Rule 506 and Rule 144A. The SEC may propose new rules within 90 days but not adopt final rules until after the deadline. The JOBS Act does not specify a date by which the SEC must adopt implementing rules for the changes to Section 12(g). If you have questions about how the JOBS Act affects your ability to market your fund, please contact us for a complimentary consultation.