by Beth Manzi and Mark Heil, PEF Services
In accordance with the JOBS Act, the SEC has proposed new rules allowing private equity firms to generally solicit and advertise for new investors. Adoption of these new rules is anticipated in 2013 (after Chairman Shapiro’s replacement is approved). The new rules will mean that private placement issuers may use communications in newspapers, television or radio broadcasts, e-mail blasts and website publications without limitation.
While it seems like good news, the caveat here is that if private securities are marketed through a general solicitation/marketing campaign, private equity firms are required to take reasonable steps to make sure that the investors are accredited or qualified institutional buyers as defined in securities law.
The SEC declined to designate or endorse any specific means of verification of investors for fears that the methods may become outdated, cumbersome or ineffective. However, it did offer guidelines to determine whether steps are reasonable based on the particular facts and circumstances of each transaction, 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 of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as the minimum investment amount.
The SEC believes these three guidelines are interrelated and the information gained by looking at all of these factors should help a fund assess the reasonable likelihood that a potential investor is accredited. Accordingly, fund managers should develop a system to document the steps taken to verify each investor and to retain those records should they be needed in the future. The SEC asserts that so long as a fund takes reasonable steps to verify that the investor is accredited or has a reasonable belief that an investor is accredited, the fund will be protected by the law even if it is later learned that an investor is not accredited.
Furthermore, the SEC states firms may continue to privately market their funds under the current rules without general solicitation. Fund managers using this option will not be subject to taking the reasonable steps to make sure their investors are accredited investors, but should only approach individuals that they reasonably believe are accredited. These rules stipulate that funds may offer and sell securities to an unlimited number of accredited investors and up to 35 non-accredited investors who meet certain requirements of being a “sophisticated investor”. The current rules are subject to a number of conditions, including the tracking of private placement memorandum.
Under the new guidelines, funds will be required to indicate on Form D whether they intend to market under the current rules or under the new rules. The SEC is ostensibly collecting this information on Form D to help it track the effectiveness of the new rule in terms of capital raising.
As with any new law, there is a certain amount of vagueness and ambiguity which will be clarified over time through precedence and clarifications from the SEC. Furthermore, fund managers should be aware that the SEC has rules about general solicitation and marketing pertaining to other types of securities (e.g., mutual funds) in terms of required materials that need to be presented, various disclosures that need to be made, the use of specific words, graphs and images, and requirement to retain copies of advertisements/solicitation materials, etc. Some or all of these rules may apply to private equity funds. If you are planning to start the capital raising process in 2013, be sure to consult with your attorney regardless of which method you plan to use.