Allows Hedge Funds to Openly Solicit Investors
President Obama has signed into law the Jumpstart Our Business Startups Act (“JOBS Act”), a law which eases some of the private investment fund industry’s long-standing regulatory burdens.
There are two parts of the JOBS Act which in particular stand out for the hedge fund industry: (1) private investment fund managers including hedge fund managers may now make general solicitations and advertise their fund in order to attract investors, as long as the funds only have accredited investors; and (2) private funds and hedge funds may now have up to 1,999 accredited investors, or 500 non-accredited investors, without having to register with the SEC under the 1934 Act. [For background information on this issue, please see section "500 or Fewer Investors" on our post about Section 3(c)(7) hedge funds.]
During the next 90 days the SEC will be promulgating regulations with respect to the changes in the securities laws.
Ban Lifted on General Solicitation and Advertising
Previously Rule 506 of Regulation D prevented private fundsfrom advertising publicly or soliciting the public for investment. This rule raised the specter of liability in numerous contexts. For example, private fund managers and employees could face serious consequences – including risking the fund’s SEC filing exemption (different from IA registration exemption) – for discussing their investment strategy with certain potential clients, or for putting their contact information on a fund’s publicly-accessible website. The JOBS Act changes this statutory scheme, allowing private funds to advertise publicly and to solicit the public for investment. It is not yet clear precisely what forms of advertising and solicitation will be permitted under the new rule. The SEC still has 90 days from the date of the signing of the JOBS Act to issue final regulations which will likely include more details on allowable advertisements and solicitation.
Increased Number of Accredited Investors
Prior to the JOBS Act, the Securities Exchange Act of 1934 required private funds to register with the SEC if they had more than 499 accredited investors (see 3(c)(7) link above). Under the new law, a private fund may have as many as 1,999 accredited investors without triggering that registration requirement. Increasing the number of permitted investors may allow private funds to raise more capital. [Note: the new law also creates a new source of financing called “crowdfunding.” A detailed analysis of this topic is beyond the scope of this blog post, but it should be noted that purchasers in a crowdfunding are not counted toward the 1,999 investor limit. Also not counted are employees who receive securities from a fund pursuant to an executive compensation plan.]
The new rules do not apply to commodity pools which are subject to other regulatory oversight from the CFTC because of the Commodities Exchange Act. In general many commodity pool operators are going through the CFTC CPO registration process because of separate CFTC rulemaking which we detailed in a previous post.
While many groups including hedge fund managers are applauding this shift in the law, the SEC is likely to craft regulations which seek to limit the full extent of the potential general solicitations. Fund managers should remember that while general solicitations may be allowable in the future, managers may still be subject to other regulations under the Investment Advisers Act, especially after the Dodd-Frank requirement for hedge funds to register with the SEC. Specifically, fund managers who are SEC registered IAs cannot use testimonials and there are a number of requirements for hedge fund performance reporting which will need to be followed. While it is clear that private fund managers will have more flexibility with respect
to advertising than before the JOBS Act was passed, managers will need to be vigilant with their compliance programs if they decide to adopt more agressive public advertising campaigns.
Many more updates on this topic are expected.
Cole-Frieman Mallon & Hunt LLP provides regulatory and legal services to the investment management community. Bart Mallon’s practice focuses on both hedge fund manages as well as the managed futures industry. Please contact us or you can reach Bart Mallon directly at 415-868-5345.