While I was waiting to see what surprises the Securities and Exchange Commission had included in the rule lifting the ban on general solicitation and advertising for private placements, the SEC slipped in an unexpected surprise. The SEC is proposing a new Rule 509.
Rule 509 would require disclosures on “any written communication that constitutes a general solicitation or general advertising.”
(1) The securities may be sold only to “accredited investors,” which for natural persons are investors who meet certain minimum annual income or net worth thresholds;
(2) The securities are being offered in reliance on an exemption from the registration requirements of the Securities Act and are not required to comply with specific disclosure requirements that apply to registration under the Securities Act;
(3) The Commission has not passed upon the merits of or given its approval to the securities, the terms of the offering, or the accuracy or completeness of any offering materials;
(4) The securities are subject to legal restrictions on transfer and resale and investors should not assume they will be able to resell their securities;
(5) Investing in securities involves risk, and investors should be able to bear the loss of their investment.
(6) For private funds: the securities offered are not subject to the protections of the Investment Company Act.
These are not a big deal by themselves. I already have some variation of these lined up for pitchbooks and marketing materials. Given that we have no better definition of what constitutes “general solicitation and advertising” I expect we’ll see these in all materials.
The other requirement is a disclosure for performance data used by private funds.
- the performance data represents past performance.
- past performance does not guarantee future results.
- current performance may be lower or higher than the performance data presented.
- the private fund is not required by law to follow any standard methodology when calculating and representing performance data.
- the performance of the private fund may not be directly comparable to the performance of other funds.
- a telephone number or a website where an investor may obtain current performance data.
Again, I don’t think any of these are a big deal. I think that private fund managers will merely need to adjust their disclosures pages to include this information.
The new Rule 509 also requires that performance data must be of the most practicable date and you must disclose the period for which performance is presented.
The mutual fund industry was concerned about the advertising for hedge funds alongside the highly regulated advertising for mutual funds. Clearly, the SEC is trying to level the playing field. Mutual funds are limited in what they can do. I suspect they were concerned that hedge funds would be able to make more wild claims and not have to spew out the legal disclaimers that take up a big chunk of mutual fund advertising.
Lastly, if the performance presentation does not include the deduction of fees and expenses, the private fund must disclose that the presentation does not reflect the deduction of fees and expenses and that if such fees and expenses had been deducted, performance may be lower than presented.
I suspect this one is designed to scoop up the venture capital funds that managed to escape the investment adviser registration requirement under Dodd-Frank. Funds with registered fund managers already have to present net returns.
Rule 509 is merely proposed so it could be changed. But I doubt we will see any changes. The SEC will want to keep a tight lid on private fund advertising. I expect this rule will be ready to go shortly after advertising is permitted.
I don’t find anything particularly objectionable in Rule 509. The SEC clearly states in the release that failure to comply will not result in loss of the 506(c) offering.
However, a failure to comply that results in a enforcement action could lead to a ban under the new Rule 507(a). It’s not a footfault; it requires an action by the SEC or the courts. I suspect a examiner seeing a mistake will not blow up the private placement unless the examiner refers it to enforcement and enforcement decides to bring charges.
The other hook is a proposed change to Rule 156 under the Securities Act that would make it apply to private funds. More that later.
It’s amazing that the SEC realizes that it is unreasonable to propose an automatic loss of the ability to use Rule 506 in future offerings because of a failure to abide by proposed Rule 509 yet sees fit to provide for an automatic loss of exemption for future Rule 506 offerings because of a failure to file Form D. The SEC seems to have its priorities backwards. Rule 509 is (a) overall pretty reasonable and (b) specifically geared towards investor protection, which is after all, the reason why we have securities laws in the first place. In contrast, the requirement to file Form D is mere paperwork which does little to advance the interest of investors and seems only geared towards creating a government data mining machine.
Seems the best way to fix the proposed rule on Form D is to require the SEC to actually pursue an enforcement action for an unfiled Form D before there is the loss of a future exemption.
Agreed. I’m still trying to get my arms around the Form D requirements.
Even the new form does not require that much information and none of it would seem so important that it would need to filed before the solicitation, as opposed to before the first sale. The penalty is draconian.