Overview of the JOBS Act
Signed into law by President Obama on April 5, 2012, the Jumpstart Our Business Startups Act (the “JOBS Act”) was intended to stimulate job creation by reducing regulatory restrictions and associated costs that tend to stymie the growth of small businesses. The JOBS Act has potentially enormous implications for the investment management (and hedge fund) industry.
Elimination of General Solicitation Prohibition
Title II of the new law eliminates the prohibition against general solicitation and advertising in certain securities offerings. The idea was that small businesses, particularly those with less than $1 billion in assets under management, would be able to implement more aggressive marketing strategies to reach investors via the public markets and the Internet to obtain capital. These new-found advertising liberties would theoretically enable companies to go public sooner, spurring the creation of new jobs. For the hedge fund industry, this potentially means the ability to advertise publicly and solicit the public for investment.
Review of the SEC’s Proposed Rule
We have cautioned managers to hold off on any aggressive advertising campaign until after the SEC has promulgated regulations. While the new law ushers in an era of increased marketing freedom for private funds, it is unclear what limits the SEC will place on permitted activities. Based on its proposed rule, the SEC seems intent on curtailing some of the solicitation and advertising rights initially provided under the JOBS Act.
Specifically, the SEC proposed the following amendments to Title II:
• Proposed Rule 506(c): The SEC’s proposed rule would permit the use of general solicitation to offer and sell unregistered securities under Rule 506. The catch is that the purchasers of the securities must all be accredited investors, which we have defined in previous posts [hyperlink]. The issuer must take “reasonable steps” to verify that they are accredited investors.
The SEC declined to issue specific methods of verification. Rather, the reasonableness of the steps would be determined by the particular facts and circumstances of each transaction, including:
o The nature of the purchaser and the type of accredited investor the purchaser claims to be;
o The amount and type of information that the issuer has about the purchaser;
o 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 a minimum investment amount
It is noteworthy that the SEC confirmed that privately offered funds making general solicitations under Rule 506(c) may still qualify for Section 3(c)(1) and 3(c)(7) exemptions.
• Proposed Form D Check Box for Rule 506(c) Offerings: Under Rule 503 of Regulation D, an issuer offering or selling securities under Rule 506 must file a notice of sales on Form D for each new offering. The SEC proposed a revision to Form D to add a separate field or check box for issuers to indicate whether they are claiming an exemption under Rule 506(c). The purpose behind this revision is to allow the SEC to monitor the use of general solicitation in Rule 506(c) offerings and to help “look into the practices that would develop to satisfy the verification requirement.”
• Proposed Amended Rule 144A(d)(1): Rule 144A governs the resale of unregistered securities by large institutional investors, required under pre-JOBS Act law to be qualified institutional buyers (“QIBs”). The JOBS Act directs the SEC to amend these rules to allow unregistered securities to be offered to persons other than QIBs. The law also clarifies that these offerings may be conducted by means that include general solicitation. The SEC proposed that securities under this provision may be offered to persons other than QIBs as long as the securities are sold only to persons whom the seller and any person acting on behalf of the seller “reasonably believe” are QIBs.
• Regulation S Clarification: The SEC clarified that offshore offerings under Regulation S would not be integrated with concurrent domestic unregistered offerings under Rule 506(c) and 144A. This suggests that firms can still conduct offerings under Regulation S even though they simultaneously conduct general solicitations domestically, as permitted by the new rules.
What you need to know next…
One year later, the SEC has yet to promulgate rules to implement the JOBS Act. Although the law mandated the SEC to revise existing rules to reflect those outlined in Title II within 90 days of enactment, the SEC missed that deadline. On August 29, 2012, the SEC released a proposed rule with amendments. This was open for comment until October 5, 2012. The final rule is still pending.
On Thursday, April 11, 2013, at 10 a.m., the Subcommittee on Investigations, Oversight and Regulations of the House Select Committee on Small Business is holding a “JOBS Act Implementation Update” hearing. The objective of the hearing is to review the SEC’s efforts to implement the law and examine how delays have affected small business.
In conclusion, although it seems that firms may now engage in capital-raising efforts such as website advertising, media broadcasts, email campaigns, and public seminars and meetings, it remains to be seen how aggressive the SEC will be in overseeing solicitation and advertisement. At the very least, managers should expect the SEC to promulgate rules on recordkeeping, truthful advertising, and fact-checking with respect to the accredited status of investors.