Wednesday, September 12, 2012

The JOBS Act: SEC Proposes Rules to Permit General Solicitation and General Advertising in Certain Private Placements

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”), a collection of reforms to the U.S. federal securities laws designed to reduce the regulatory burdens on small businesses and facilitate capital formation.1 The JOBS Act directed the Securities and Exchange Commission (the “SEC”) to amend Rule 506 of Regulation D under the Securities Act of 1933 to permit general solicitation or general advertising in unregistered offerings made under Rule 506, provided that all purchasers are accredited investors. The SEC proposed rules on August 29, 2012 to implement that requirement.

Proposed Amendments to Rule 506    
Section 4(a)(2) of the Securities Act exempts from registration the offer and sale of securities by an issuer in a transaction “not involving any public offering.” This exemption has been interpreted to restrict an issuer from using public announcements, advertising or general solicitations when offering and selling securities. Rule 506, which creates a “safe harbor” for issuers seeking to use the Section 4(a)(2) exemption, currently prohibits the issuer, or any person acting on its behalf, from offering or selling securities through any form of general solicitation or general advertising.


To implement the JOBS Act, the SEC proposes to add new Rule 506(c), which would permit the use of general solicitation to offer and sell securities under Rule 506, provided that:
  • the issuer takes reasonable steps to verify that the purchasers are accredited investors;
  • all purchasers of securities are accredited investors, either because they fit within one of the categories of persons that qualify as accredited investors or the issuer reasonably believes that they do, at the time of the sale of securities; and
  • the other requirements of Regulation D (other than the general solicitation prohibition) are satisfied.
     
The proposed amendments preserve under Rule 506(b) the current exemption that allows issuers to conduct Rule 506 offerings without the use of general solicitation and general advertising. Issuers that choose to rely on Rule 506(b) would not be subject to the new requirement that they take “reasonable steps” to verify a purchaser’s accredited investor status (i.e., they can rely on an investor’s self-certification or a pre-existing substantive relationship with the investor) and they may still sell privately to up to 35 non-accredited investors who meet Rule 506(b)’s sophistication requirements.

Verification of Accredited Investor Status

The SEC noted that the purpose of the verification mandate is to address concerns, and reduce the risk, that the use of general solicitation under Rule 506 may result in sales to non-accredited investors. The SEC noted that under the proposed rule, whether the steps taken by an issuer to verify that all purchasers are accredited investors are “reasonable” would be an objective determination that is based on the facts and circumstances of each transaction. The SEC also noted that amendments to Rule 506 must be flexible to accommodate different types of issuers and different types of accredited investors that may purchase securities in these offerings. The SEC provided a non-exclusive list of factors that an issuer would consider when determining the reasonableness of the steps taken to verify that a purchaser is an accredited investor, including:
  • 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; and
  • the nature and terms of the offering, including the manner in which the issuer was solicited and whether it requires a high minimum investment amount.
Nature of the Purchaser
The definition of accredited investor in Rule 501(a) of Regulation D identifies several different types of accredited investors including both natural persons and entities. The steps that would be reasonable for an issuer to take to verify whether a purchaser is an accredited investor thus vary depending on the type of accredited investor that the purchaser claims to be. For example, registered broker-dealers are accredited investors. An issuer can easily verify the registered status of a broker-dealer and thereby satisfy the verification requirement. Verification of a natural person investor, on the other hand, presents significant challenges because many investors will be reluctant to provide copies of their tax returns or W-2 Forms. The SEC acknowledges that verification of the accredited investor status of natural persons poses practical difficulties that are exacerbated by privacy concerns about disclosing personal financial information.
Amount and Type of Information about Purchaser
The SEC indicates that the amount and type of information that an issuer has about a purchaser is a significant factor in determining what additional steps would be reasonable to verify accredited investor status. The SEC provides examples of the types of information that issuers could review or rely upon to constitute reasonable steps to verify a purchaser’s accredited investor status, including:
  • Publicly available information in filings with a federal, state or local regulatory body;
  • Third-party information that provides reasonably reliable evidence, such as W-2 Forms, tax returns or trade publications; and
  • Verification of a person’s status by a third party, such as a broker-dealer, attorney or accountant, provided that the issuer has a reasonable basis to rely on such third-party verification.
Nature and Terms of the Offering
Another factor that the SEC instructs issuers to consider when verifying the accredited status of investors is the nature and the terms of the offering. The issuer should consider the means through which the issuer publicly solicits purchasers. According to the SEC, an issuer that solicits new investors through a website accessible to the general public or through a widely disseminated email or social media solicitation would likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party such as a registered broker-dealer. As a result, issuers may begin to utilize the services of broker-dealers who have amassed a large pool of pre-screened accredited investors. In such case, the issuer could presumably rely upon the broker-dealer to verify the accredited status as long as the issuer understands the methods used by the broker-dealer to undertake the pre-screening and the issuer reasonably believes that the broker-dealer is conducting such pre-screening effectively.
Form D Check Box for Rule 506(c)
The proposed rules also would revise Form D to add a separate check box for issuers to indicate whether they used general solicitation or general advertising in a Rule 506 offering.
Specific Issues for Privately Offered Funds
The SEC also confirmed that privately offered funds such as hedge funds, venture funds and private equity funds would be able to utilize general solicitation and general advertising to raise capital under Rule 506(c) without running afoul of restrictions under the Investment Company Act of 1940.
Proposed Amendment to Rule 144A
In addition to mandating changes to Rule 506, the JOBS Act directs the SEC to revise Rule 144A(d)(1) under the Securities Act to provide that securities sold pursuant to Rule 144A may be offered to persons other than QIBs,2 including by means of general solicitation or general advertising, provided that securities are sold only to persons that the seller and any person acting on the seller’s behalf reasonably believe is a QIB. As amended the rule would require only that the securities are sold to a QIB or to a purchaser that the seller and any person acting on behalf of the seller reasonably believe is a QIB. Under the amended rule, resales of securities pursuant to Rule 144A could be conducted using general solicitation, so long as the purchasers are similarly limited.
No Integration with Offshore Offerings
The SEC made it clear that its long-standing policy that offshore offerings under Regulation S are not integrated with domestic offerings under Regulation D is unchanged by the JOBS Act and related rule amendments.
Conclusion
There will be a 30-day comment period on the proposed rules from the date the rule proposal is published in the Federal Register. If the Final Rules closely resemble those proposed then Issuers should take a totality of the circumstances approach when developing reasonable accredited investor verification procedures. The type of accredited investor the purchaser claims to be, the type of information available about that purchaser and the nature and terms of the offering should all be examined in their entirety to determine how extensive the verification process should be.


1. The text of the JOBS Act, as passed by the House on March 27, 2012, is available at http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf. For a more comprehensive discussion of the changes to U.S. federal securities laws instituted by the JOBS Act, please see our earlier client alert, The U.S. Jumpstart Our Business Startups Act (The JOBS Act), available at http://www.curtis.com/siteFiles/Publicati ons/Public%20Company%20Client%20Alert.pdf.
2. QIBs are defined generally as institutions that own and invest at least $100 million in securities on a discretionary basis.

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Friday, April 6, 2012

The JOBS Act: Implications for Private Fund Sponsors

Introduction

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”), a collection of reforms to the U.S. federal securities laws designed to reduce the regulatory burdens on small businesses and facilitate capital formation.[1] Although the JOBS Act is primarily aimed at helping small and emerging businesses grow and create jobs, private fund sponsors will also see significant benefits from the new legislation.[2] In particular, the JOBS Act (i) raises the threshold for the number of equity holders a private fund can have before it becomes a public company subject to periodic and current reporting under the Securities Exchange Act of 1934 (the “Exchange Act”) and (ii) permits general solicitation or general advertising in connection with offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act of 1933 (the “Securities Act”).


Increased Threshold for Exchange Act Reporting

Prior to the JOBS Act, Section 12(g) of the Exchange Act required a company with more than $10 million in total assets and a class of equity security “held of record” by 500 or more persons to register the class of equity security with the SEC. Because Exchange Act registration triggers public company reporting obligations, sponsors of private funds that rely on the exemption from registration under Section 3(c)(7) of the Investment Company Act of 1940 (the “Investment Company Act”) have tended to limit the number of investors in those funds to no more than 499 persons.[3] Section 501 of the JOBS Act raises the record holder threshold in Section 12(g)(1)(A) of the Exchange Act from 500 persons to either (i) 2,000 persons or (ii) 500 persons who are not “accredited investors.”[4] In addition, Section 502 of the JOBS Act amends Section 12(g)(5) of the Exchange Act to provide that the definition of “held of record” excludes securities held by persons who received the securities pursuant to an employee compensation plan in a transaction exempt from the registration requirements of Section 5 of the Securities Act. To assist issuers in structuring their employee compensation plans, Section 503 of the JOBS Act directs the SEC to adopt safe harbor provisions that issuers can follow when determining whether an employee security holder meets the exclusion. The JOBS Act amendments to the Section 12(g) record holder provisions take effect immediately; however, no deadline is given for the SEC to adopt safe harbor provisions for the employee security holder exclusion.

Because a private fund relying on the Section 3(c)(7) exemption is limited to investors who are “qualified purchasers”[5] – each of whom would also qualify as an accredited investor – these changes effectively increase the number of investors the fund can accept for each class of its securities from 499 to 1,999, plus any excluded employee security holders.

Anti-Evasion Rules to be Reconsidered

The 500 record holder limitation in Section 12(g) of the Exchange Act received significant media attention last year when it was revealed that Goldman Sachs had organized a special purpose vehicle (“SPV”) to allow its clients to invest in Facebook.[6] Under Rule 12g5-1, securities held of record by a single entity such as an SPV will generally be treated as held of record by one person, regardless of how many beneficial owners the SPV has. If Goldman’s clients had invested in Facebook directly, each of them would have counted toward the 500 record holder limit, which could have forced Facebook to become a public company subject to Exchange Act reporting before it was ready to conduct its IPO. To many, the investment by Goldman’s SPV appeared to run afoul of the anti-evasion provision in Rule 12g5-1(b)(3), which provides that if the issuer (e.g., Facebook) “knows or has reason to know that the form of holding securities of record is used primarily to circumvent” the 500 record holder limitation, then “the beneficial owners of such securities shall be deemed to be the record owners thereof.”

The scrutiny of Goldman’s Facebook investment prompted concern in the private fund industry that sponsors of so-called “master funds” may be required to count the beneficial owners of “feeder funds” formed to invest in the master fund as record holders, even in cases where the feeder funds were formed by persons unaffiliated with the master fund’s sponsors. SEC Chairman Mary Schapiro has acknowledged that SPV investments in private companies such as Facebook raise a number of policy questions, including whether SEC rules should count the holders of the SPV as record holders for purposes of Section 12(g) registration, regardless of the purpose for which the SPV was formed.[7]

In light of the uncertainty surrounding the application of Rule 12g5-1(b)(3), Section 504 of the JOBS Act directs the SEC to examine its authority to enforce Rule 12g5-1, determine if new anti-evasion enforcement tools are needed, and submit its recommendations to Congress within 120 days.

General Solicitation and General Advertising of Private Offerings Under Rule 506 of Regulation D

In addition to increasing the number of potential investors that a private fund can have before becoming a public company, the JOBS Act makes it easier for private fund sponsors to offer interests in their private funds without having to register the offering under the Securities Act. Private funds relying on either the Section 3(c)(1) or 3(c)(7) exclusion from the Investment Company Act registration are prohibited from engaging in a public offering of their securities. Interests in such funds are thus typically offered and sold in private offerings pursuant to Rule 506 of Regulation D under the Securities Act, which prohibits any general advertising or general solicitation in connection with the offering.

Section 201 of the JOBS Act directs the SEC to revise Rule 506 to remove the prohibition against general solicitation or general advertising in connection with Rule 506 offerings where all purchasers of the securities sold in the offering are accredited investors. The SEC’s rules must also require that the issuer take reasonable steps to verify that purchasers of the securities are accredited investors using such methods as will be determined by the SEC. The JOBS Act gives the SEC 90 days following the passage of the Act to make the necessary rule revisions.

Furthermore, Section 201(b)(2) of the JOBS Act clarifies that offers and sales conducted pursuant to Rule 506 “shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation.” Accordingly, subject to the adoption of the SEC’s amendments to Rule 506, private fund sponsors should be able to use general advertising or general solicitation to offer interests in their Section 3(c)(1) or 3(c)(7) funds without jeopardizing their ability to rely on those exemptions from Investment Company Act registration. As a result, we expect that private fund sponsors will expand their use of websites and social media to market private funds under Rule 506.

1 The text of the JOBS Act, as passed by the House on March 27, 2012, is available at http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf.

2 For a more comprehensive discussion of the changes to U.S. federal securities laws instituted by the JOBS Act, please see our earlier client alert, The U.S. Jumpstart Our Business Startups Act (The JOBS Act), available at http://www.curtis.com/siteFiles/Publications/Public%20Company%20Client%20Alert.pdf

3 The 500 record holder threshold is generally not a concern for a private fund relying on the exemption from registration provided by Section 3(c)(1) of the Investment Company Act, as that exemption is only available if the fund has no more than 100 beneficial owners.

4In general, an “accredited investor” includes (i) any entity with assets in excess of $5 million and (ii) any natural person (a) whose net worth, either alone or together with the person’s spouse, exceeds $1 million, excluding the value of the person’s primary residence, or (b) whose income exceeded $200,000 (or $300,000 together with a spouse) in each of the two most recent years and who has a reasonable expectation of the same income level in the current year.

5 In general, a “qualified purchaser” includes (i) an entity that owns and invests at least $25 million on a discretionary basis for its own account or for the accounts of other qualified purchasers and (ii) a natural person who, either alone or together with a spouse, owns at least $5 million in investments.

6See, e.g., Steven M. Davidoff, Facebook and the 500-Person Threshold, New York Times, Jan. 3, 2011, available at http://dealbook.nytimes.com/2011/01/03/facebook-and-the-500-person-threshold/

7Letter from Mary L. Schapiro, Chariman of the SEC, to Hon. Darrell E. Issa, Chairman, Committee on Oversight and Government Reform, U.S. House of Representatives (April 6, 2011) at 20-21, available at http://www.sec.gov/news/press/schapiro-issa-letter-040611.pdf

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Wednesday, February 15, 2012

CFTC Releases Final Rules Amending Registration and Compliance Obligations for CPOs and CTAs

On February 9, 2012, the U.S. Commodity Futures Trading Commission ("CFTC") released final rules amending the registration and compliance obligations for commodity pool operators ("CPOs") and commodity trading advisors ("CTAs"). Among other amendments, annual exemption renewals are now required to be filed with the National Futures Associates by those persons relying on the exemptions from CPO or CTA registration provided under CFTC rules 4.5, 4.13 or 4.14. Most notably, however, the CFTC is eliminating the exemption from CPO registration set forth in Regulation 4.13(a)(4), which permits a CPO to be exempted from registration with respect to any pool where (i) the interests in the pool are exempt from registration under the Securities Act of 1933, as amended, and such interests are offered and sold without marketing to the public in the U.S. and (ii) (x) each natural person participant is a "qualified eligible person" and (y) each non-natural person participant is a "qualified eligible person" or an "accredited investor". This Regulation is commonly relied upon by commodity fund managers to private investment funds that comply with Section 3(c)(7) of the Investment Company Act of 1933, as amended. For those CPOs relying on this Regulation there is a transition period until December 31, 2012, at which point they will need to register with the CFTC or rely on a different registration exemption.

Link to the Final Rules: http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister020912b.pdf

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