Some publications have predicted widespread changes in the way hedge funds and private equity funds are marketed. The speculation is based on the JOBS Act elimination of previous prohibitions on general solicitation, or advertising, in connection with Rule 506 private placements on which hedge funds and private equity funds rely when selling securities. Prior to the JOBS Act, the prohibition on general solicitation prevented hedge funds and private equity funds from advertising or contacting potential investors that the fund or the placement agent did not have a preexisting relationship. After the JOBS Act, advertising and general solicitations are permitted, so long as sales are made only to accredited investors.
While we expect the JOBS Act will have some effect on marketing of hedge funds and private equity groups, we do not believe there is a high likelihood of fundamental near-term change. There are several reasons for this:
- As a result of the Dodd-Frank Act, many larger hedge fund and private equity sponsors were required to register with the SEC as investment advisers under the Investment Advisers Act. Section 206 of the Investment Advisers Act contains an anti-fraud provision, and related SEC Rule 206(4)(1) governs advertising conduct by investment advisers. Those provisions were not changed by the JOBS Act.
- When adopting JOBS Act regulations, the SEC may foresee a waive of inappropriate marketing and take steps to further bolster prohibitions on advertisements by sponsors of hedge funds and private equity funds.
- The SEC has publicly stated that they are going to scrutinize performance claims made by hedge fund and private equity sponsors, so moderation will be the key.
- Sponsors that use FINRA registered placement agents to aid in raising funds will find those placement agents have to comply with FINRA rules.
- Hedge fund and private equity sponsors that are required to register with various state authorities because they do not qualify for SEC registration will have to consider restrictions on advertising imposed by states.
- If a hedge fund is also a “commodity pool,” CFTC and National Futures Association Rules must be considered.
The JOBS Act also increases the threshold for registration under the Exchange Act for becoming a public reporting company from more than 500 shareholders to 2,000 persons, or 500 persons who are not accredited investors. We believe this will have minimal impact on the structuring of funds. Many funds rely on the 3(c)(1) exemption from registration under the Investment Company Act, which separately limits the number of investors in a fund to not more than 100 owners. Other funds, however, rely on the Section 3(c)(7) exemption to avoid registration under the Investment Company Act. That Section requires owners of a fund to be “qualified purchasers,” which means investors that have significant funds to invest (i.e., natural persons who own$5,000,000 in investments and others who hold $25,000,000 in investments). While the Section 3(c)(7) exemption is not dependent on the number of investors, we have found that the previous 500 person threshold for Exchange Act registration was only a concern of very few funds.
The JOBS Act also includes simplifications for the registration of securities, such as the so-called “IPO On-Ramp” and an expanded Regulation A type of exemption which will permit offers and sales of securities of up to $50 million. Private equity groups may find that these simplifications make it somewhat easer to use the equity markets as an exit strategy. However, so called “crowdfunding” will not be available to raise funds for a private equity group or hedge funds under the terms of the JOBS Act.
Check jobs-act-info.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.