Tag: Rule 506

Changes to the Definition of Accredited Investor

The Securities and Exchange Commission made some small changes to the definition of “accredited investor” last week. The changes had been first proposed last December.

The definition of “accredited investor” is at the nexus of the Securities and Exchange Commission’s missions: (1) to protect investors, (2) to maintain fair, orderly, and efficient markets, and (3) to facilitate capital formation.  If you’re an accredited investor you have access to private offerings. That enables capital formation. Private offerings are not subject to review by the SEC so they have fewer protections in place for investors. The commissioners were split on their votes to approve the changes.

Lots of arguments around the accredited investor definition are about an investor’s ability to assess risk in making the investment. I’ve long argued that the risk with a private placement is not the risk of loss, but the risk of liquidity. Some private placements are very risky and some are not. All private placements are less liquid than publicly traded securities. Tesla is at a crazy price right now, but you can sell and exit out of your position in minutes. You may not be able to exit from a private placement position for years.

The big news in the changes in the definition are the items that are missing. There were no changes to the wealth or income levels for qualification. Those levels have been unchanged for decades, broadening the pool of accredited investors with inflation.

The changes to the definition really just make some small expansions.

The SEC added a new category to the definition that permits qualification based on certain professional certifications, designations or credentials.  In conjunction with the changes, the SEC designated holders in good standing of the Series 7, Series 65, and Series 82 licenses as accredited investors. These are deemed as individuals with an ability to assess risk.

For private funds, there is an application of the “knowledgeable employee” definition over to accredited investor status. The SEC established Rule 3C-5 to allow “knowledgeable employees” to invest in their company’s private fund without having to be a “qualified purchaser”. The rule also exempts these knowledgeable employees from the 100 investor limit under the Section 3(c)(1) exemption from the Investment Company Act. However, the knowledgeable employee had to separately qualify as an accredited investor. This rule change covers that gap.

In act of progressive politics, the SEC added the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

“The term spousal equivalent shall mean a cohabitant occupying a relationship generally equivalent to that of a spouse.”

There were additional marginal expansions for some investment entities.

Sources:

The New Rule 506(d) and Bad Actors

baD BOYS

At its latest meeting, the Securities and Exchange Commission approve the rule that lifted the ban on general solicitation and advertising for certain private placements. The SEC also adopted the new rule that disqualifies felons and other bad actors from participating in certain securities offerings. The first rule was mandated by the JOBS Act. The “bad actor” rule was mandated by Dodd-Frank.

The bad actor rule makes private placements a bit harder and will require private funds and companies to do more homework in connection with the fundraising. That’s because an issuer cannot rely on the Rule 506 exemption if the issuer or any other person covered by the rule had a “bad actor disqualification.”

I think the starting point is who is covered by the rule. The rule applies to

  • The issuer, including its predecessors and affiliates
  • Directors, executive officers, general partners, and managing members of the issuer
  • Any other officer participating in the offering
  • Anyone who holds 20% or more of the outstanding voting equity securities
  • Investment managers and principals of pooled investment funds
  • Any general partner or managing member, director, executive officer or other officer participating in the offering of a fund sponsor
  • Solicitors paid to sell the securities investors as well as the general partners, directors, officers, managing members or other officer participating in the offering

For fund managers registered with the SEC the employees affected are a narrower group than those in Item 11 on Form ADV. That part of the Form ADV disclosure applies to all employees, other than employees performing only clerical, administrative, support or similar functions. Plus the Form ADV includes all of the officers, partners, directors, and certain affiliates.

The big difference is the 20% threshold for ownership in the company. For startups, that would likely pull some angel investors into the “actor” category.

It’s not clear what to do if the 20% investor is an entity. The rule does not seem to cover that circumstance. I suppose that if Bernie Madoff set up Scumbag Bernie Investor LLC to invest in the fund that would be a mere facade to hide his ownership. If the entity has multiple owners and officers it seems that a single “bad actor” inside the investor should not taint the whole entity.

The other fuzzy item is “officers participating in the offering.” The SEC had declined to merely use job title as the defining line. That would have included everyone who had the title of vice president.

Participation in an offering would have to be more than transitory or incidental involvement, and could include activities such as participation or involvement in due diligence activities, involvement in the preparation of disclosure documents, and communication with the issuer, prospective investors or other offering participants.

I’m not sure how I feel about that guidance. A lot of people end up reviewing the Private Placement Memorandum.

Of those relevant actors to determine if they were bad, they need to have been involved in a “disqualifying event” which includes:

  • Criminal convictions in connection with financial fraud.
  • Subject to an order of judgement that limits involvement in the securities industry.
  • Subject to an order of judgement that limits involvement in the banking industry
  • Subject to an order of judgement from the CFTC.
  • Subject to a US Postal Service false representation order.

The actual list is much more convoluted, long, and unwieldy. That means putting together a questionnaire will be difficult. For private fund adviser, it does not match up squarely with the Form ADV disclosures and is not as clearly written as the Form ADV disclosures.

The default would be to put together a questionnaire and just use the text of Rule 505(d). I’m not sure it’s comprehensible by a non-lawyer. Actually, I’m not sure it’s easily comprehensible by a lawyer. I just added it to my questionnaire for Form ADV, making it extend to four pages.

The next question is how much diligence you need to conduct to determine if one of your “actors” is a “bad actor”? The rule requires the issuer to exercise “reasonable care.” Which in “light of the circumstances, the issuer made a factual inquiry into whether a disqualification exists.”

That’s the kind of fuzziness that keeps a compliance officer up at night.

Fortunately, the SEC offers some color to the “reasonable care” in the release.

For example, we anticipate that issuers will have an in-depth knowledge of their own executive officers and other officers participating in securities offerings gained through the hiring process and in the course of the employment relationship, and in such circumstances, further steps may not be required in connection with a particular offering.

So the questionnaire approach should work for employees, unless you have some suspicion that an employee has been up to no good.

What about for investors?

Factual inquiry by means of questionnaires or certifications, perhaps accompanied by contractual representations, covenants and undertakings, may be sufficient in some circumstances, particularly if there is no information or other indicators suggesting bad actor involvement.

That’s enough to let me fall asleep at night. Maybe I’ll need just a little bourbon to take the edge off.

Sources:

Crowdfunding and the Ban on General Solicitation

18 Rabbits Bars

While entrepreneurs are looking to create crowdfunding portals under Title III of the JOBS Act, small business owners looking to raise capital should keep an eye on the regulatory changes under Title II of the JOBS Act. That may do a better job of opening the spigot for capital than the avalanche of crowdfunding portals likely to appear.

Look at the case of Alison Bailey Vercruysse, a maker of granola-based foods, and her company 18 Rabbits. According to a story in yesterday’s Washington Post, her products attracted a loyal following, but she could not tap those fans for capital as she tried to grow her firm.

“People would come up to me in different places and say: ‘I’m interested in investing in your company. How can I do that?’ ” Vercruysse said. “I couldn’t say we were trying to raise money. I’d end up saying things like; ‘Buy our granola. That would help us.’ ”

Without the ban on general solicitation, the company could put a message on its packaging or its website for accredited investors interested in investing.

Currently, the Securities and Exchange Commission has a ban on the use of general advertising and solicitation for raising private capital under the most popular exemption, Rule 506. Title II of the JOBS Act requires the SEC to remove that ban for offering where all investors are accredited. The agency tried to rush the rules last summer to meet the Congressional deadline, but investor advocates demanded that the SEC slow down. The SEC is gathering public comment before finalizing the rule.

Two SEC commissioners, Dan Gallagher and Troy Paredes, were in favor of immediately lifting the ban. SEC Commissioner Luis Aguilar did not like the rule, saying it lacked adequate investor protections. The fourth SEC Commissioner, Elise Walter voted for the proposal, but expressed concerns. She has stated the SEC must consider ways to mitigate potential harm to investors. The fifth and presumably deciding Commissioner’s seat is vacant with the departure of Mary Shapiro. Looking into my crystal ball, it would seem that the rule is not going to be finalized anytime soon. At least not until the vacancy is filled.

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What Will the SEC Do About Advertising and Solicitation?

UPDATE: The SEC will wait a week. A new meeting has been scheduled for August 29.

At today’s meeting the Securities and Exchange Commission is set to consider a rule on lifting its longstanding ban on general solicitation and advertising for privately-issued securities.

Item 3: The Commission will consider rules to eliminate the prohibition against general solicitation and general advertising in securities offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act and Rule 144A under the Securities Act, as mandated by Section 201(a) of the Jumpstart Our Business Startups Act

Personally, I would welcome better information about what the SEC considers a general solicitation or general advertisement in connection with the private placement of securities. I don’t think lifting the ban is necessarily a good idea. The appearance of an ad for a private security has been a prominent red flag for an offering. Either it’s a fraud or the company is ignoring the advice of its legal counsel.

The bigger concern is what the SEC will do about verifying that the potential investor meets the accredited investor standard. Currently, most fund manager use a certification filled out by the investor. In addition to meeting the accredited investor standard, the questionnaire will typically include many other items of disclosure.

This process has worked well for decades. Hopefully the SEC won’t mess it up.

If you are wondering what changes the SEC could make, McGuire Woods put together an excellent Preview of New SEC Provisions Permitting Advertised Private Placements. The report tries to summarize the numerous comments submitted to the SEC.

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Comments on Advertising Restrictions for Private Funds

Section 201 of the recently passed Jumpstart Our Business Startups Act will change the advertising limits on private funds and any other company that raises capital through the private placement safe harbor in Rule 506 of Regulation D. That rule has historically prevented the use of general solicitation and advertising in selling private fund interests. Section 201 requires the SEC to lift the ban through a new rulemaking and gave the SEC 90 days (July 4) to do so.

I still find it strange that Congress did not just create revise the underlying statutes to allow solicitation and advertising in private offerings not registered with the SEC. Instead, Congress took the convoluted route of requiring the SEC to change a rule that interprets a statutory provision of the Securities Act. That injects some uncertainty into what limitations, if any, the SEC will continue to require after July 4 (or whenever the new rule goes into effect).

There are a few other points in Section 201 that concern me and make me worry about fundraising in the post JOBS Act regulatory world.

First, Section 201 limits sales only to accredited investors when using general advertising or solicitation. Currently, a Rule 506 offering can have up to 35 non-accredited investors. That would typically include friends and family investors. It would also include employees.

Second, Section 201 requires the SEC to include a requirement that the issuer take reasonable steps to determine accredited investor status using methods determined by the SEC. That could radically change the current practice and safeguards in the fundraising process.

Third, I’m concerned what the effect will be for a fund or other issuer that ends up selling to a non-accredited investor. A fund can take reasonable steps to determine if a potential investor is accredited. But the investor could be deceptive. That would leave the fund in violation even though it reasonably believed the investor was accredited.

Fourth, Section 201 purports to lift the ban across all federal securities law. In particular, I’d prefer clarification that the advertising and solicitation applies to the Section 3(c)(1) and 3(c)(7) of the Investment Company Act that permits most private funds to avoid regulation under that law.

In looking through the comments letters to Section 201, I see that I am not alone in these concerns.

The American Bar Association’s Federal Regulation of Securities Committee does a a great job of focusing on my fourth concern and asks for a clear statement that “an offering of fund shares pursuant to Rule 506 or Rule 144A utilizing general solicitation or general advertising will not be a ‘public offering’ for the purposes of Section 3(c)(1) or 3(c)(7) of the Investment Company Act.”

The letter also requests clarification of the reasonable belief standard in the Rule 501 definition of accredited investor.

“any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person…”

The letter falls short in its comments to the verification practice. It merely asks the SEC to have the rule reflect “current custom and practice” without letting the SEC what the customs and practice is. (It’s asking the investor to fill out a questionnaire.)

In it’s comment letter, the Managed Fund Association focuses on reasonable steps for the verification process.

In general, each potential hedge fund investor must complete a subscription document provided by the fund’s manager that provides a detailed description of, among other things, the qualification standards that a purchaser must meet under the federal securities laws. In completing the subscription materials, each investor must identify which applicable qualification standard it meets. In addition to these procedures, many hedge funds managed by MFA members obtain further assurance of the qualification of their investors by virtue of minimum investment thresholds that meet or exceed the net worth requirement in the definition of accredited investor.

The Managed Fund Association also asks that the knowledgeable employee exemption be extended to Rule 506. With private funds, investors prefer (demand?) that senior management have a significant investment in the fund. This aligns interests among the investors and management. When operating under the Section 3(c)(7) exemption from the Investment Company Act, the issue then becomes how a private investment fund can provide an equity ownership to key employee when it’s unlikely that your key employees will have the $5 million in investments needed to qualify as  a Qualified Purchaser. The SEC established Rule 3C-5 to allow “knowledgeable employees” to invest in their company’s private fund without having to be a qualified purchaser. The rule also exempts these knowledgeable employees from the 100 investor limit under the Section 3(c)(1) exemption from the Investment Company Act. The Managed Fund Association recommends

that as part of the implementation of Section 201, the SEC amend the definition of “accredited investor” to include those individuals who meet the definition of “knowledgeable employee” in Rule 3c-5 under the Investment Company Act.

The New York City Bar splits the verification process by asking for a principle-based approach with a non-exclusive safe harbor. Their comment letter points out the body of existing practice and asks the SEC to build on it, rather than replace it.

The clock is ticking and the SEC has very little time to produce a proposed rule for comment. I wouldn’t be surprised to see the SEC miss the deadline given all of the other rule making piled up in front of them. That means the advertising may have to wait that much longer.

Sources – Comment letter from:

Will Private Funds Be Excluded?

Title II of the Jumpstart Our Business Startups Act directs the SEC to lift the ban on general solicitation and advertising under Rule 506 of Regulation D. That rule creates a safe harbor that deems the covered transactions to not involve any public offering within the meaning of section 4(2) of the Securities Act.

However, private funds also have to deal with the restriction in the Investment Company Act that also limits public offerings. Under the exclusions in 3(c)1 and 3(c)7 the fund must be an issuer “which is not making and does not presently propose to make a public offering of its securities”. Historically, the SEC has interpreted the meaning of “public offering” to be the same between the two acts. So not being a public offering under Rule 506 meant the offering was not public under the Investment Company Act.

For real estate fund managers relying on the 3(c)5 exclusion, there is no ban on a public offering in that exclusion.

The JOBS Act requires the SEC to revise its rule, so we don’t know exactly how the changes to Rule 506 will work. It’s possible that the SEC will limit the changes to the Securities Act and not open general advertising to funds under 3(c)1 and 3(c)7 who are required to be private.

However, Section 201(b) of the JOBS Act contains this:

(b) CONSISTENCY IN INTERPRETATION.—Section 4 of the Securities Act of 1933 (15 U.S.C. 77d) is amended—

(1) by striking ‘‘The provisions of section 5’’ and inserting

‘‘(a) The provisions of section 5’’; and

(2) by adding at the end the following:

‘‘(b) Offers and sales exempt under section 230.506 of title 17, Code of Federal Regulations (as revised pursuant to section 201 of the Jumpstart Our Business Startups Act) shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation.’’.

(My emphasis)

I assume the Investment Company Act is part of the “Federal securities laws.” I suppose you could argue that the Investment Advisers Act and the Investment Company Act operate separately from the Securities Act and the Exchange Act. That would be a tough argument for the SEC to make. The SEC could explicitly not include 3(c)1 and 3(c)7 under the changes to Rule 506.

That would seem unlikely. Take a look at the SEC’s own website “Researching the Federal Securities Laws Through the SEC Website” where it lists the Investment Company Act and Investment Advisers Act as part of the federal securities laws.

More likely would be the SEC issuing a rule with no mention of 3(c)1 and 3(c)7 or the Investment Company Act. That might leave practitioners a bit nervous about the gap.

Sources:

Accredited Investors and the JOBS Act

The Jumpstart Our Business Startups Act repeals the SEC’s ban on general solicitation and advertising under Rule 506. That is the exemption from registration used by most private fund managers. Is this a good thing?

I didn’t like the ban, mostly because it was so broad. The SEC gave little guidance as to what was advertising in support of the company and what was advertisement in support of the sales of securities. I would have welcomed better guidance. Now it looks like private fund managers will be free to have late-night television ads, email campaigns, twitter accounts, and Facebook fan pages.

Section 201(a) gives the SEC 90 days to

“revise its rules issued in section 230.506 of title 17, Code of Federal Regulations, to provide that the prohibition against general solicitation or general advertising contained in section 230.502(c) of such title shall not apply to offers and sales of securities made pursuant to section 230.506, provided that all purchasers of the securities are accredited investors.”

At first, I thought the last proviso was extraneous. Rule 506 allows unlimited fundraising as long, but it’s limited to accredited investors. But that’s not right. Rule 506 allows up to 35 investors that are not accredited, as long as they are “sophisticated” – have sufficient “knowledge and experience in financial and business matters” to make them “capable of evaluating the merits and risks of the prospective investment”.

If a manager is going to advertise that it is fundraising, then it needs to ban those previously allowed 35, even if they are sophisticated. Money rules. You need $ 1 million, excluding your primary residence, or $200,000 in income, $300,000 income with your spouse. It doesn’t matter if you are sophisticated. Even though the Crowdfunding section of the JOBS Act is supposed to allow a broader range of capital sources, this part of the law cuts off access to non-accredited investors.

That means fund managers may have to cutoff  “friends and family” investors from the fund, unless they are accredited investors.

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Lifting the Ban on General Solicitation

From a  securities compliance perspective, when you  see an advertisement or an email seeking capital for an investment opportunity there is most likely a problem. Now there is a bill in Congress that would change that view.

When selling a security, you need to register the security or find an appropriate exemption from registration. Most likely a private fund or an entrepreneur would try to fall under one of the exemptions under Regulation D. If the company is seeking over $1,000,000 they are prohibited from offering to sell the securities “by any form of general solicitation or general advertising“. Before asking someone to make an investment, you need to have a preexisting, substantive relationship.

“The types of relationships with offerees that may be important in establishing a general solicitation has not taken place are those that would enable the issuer (or a person acting on its behalf) to be aware of the financial circumstances or sophistication of the person with whom the relationship exists or that otherwise are of some substance and duration.” Mineral Lands Research & Marketing Corp., S.E.C. No-Action Letter, 1985 WL 55694 (Dec. 4 1985).

Representative Kevin McCarthy (R-CA) introduced the Access to Capital for Job Creators Act (HR 2940) which require the Securities and Exchange Commission to revise its rules to permit general solicitation in offerings under Rule 506 of Regulation D.

In my view, I don’t think there should be an elimination of the ban on general advertising and general solicitation. That would just expose large segments of the population to potential securities fraud. Currently, ads for investment opportunities are red flags for state and federal regulators.

However, I do think it needs to a little easier for entrepreneurs to raise capital. The SEC should offer some better guidance on the limitation. They could also offer some programs and safe harbors. I assume the SEC is waiting for someone to approach them with examples. They continue to be too underfunded and too understaffed to be proactive.

Will the Access to Capital for Job Creators Act be enacted? I doubt that it would pass in its current form. It takes away some investor protection and warning system for securities regulators. That would seem a bad position when the country is stealing trying to recover from the massive losses of 2008.

Sources:

Felons and Fund Managers

Most private funds rely on a Rule 506 exemption under Regulation D to sell their limited partnership interests to investors. A new SEC rule amending Rule 506 should catch the eye of private fund compliance officers. The concept it fairly straight-forward: felons should not be allowed to take advantage of the private offering exemptions.

Dodd-Frank

Section 926 of Dodd-Frank requires the SEC to adopt rules disqualifying an offering from reliance on Rule 506 of Regulation D when certain felons or other “bad actors” are involved in the offering. Rule 506 is the most widely claimed exemption under Regulation D. For the 12 month period ended September 30, 2010 the Commission received 17,292 initial filings for offerings under Regulation D, of those 16,027 claimed a Rule 506 exemption.

What types of felonies?

The  proposal is not for all felonies, just those related to the securities industry. So you could be a convicted Under the proposed rule, a “disqualifying event” would include:

  • Criminal convictions in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries. The criminal conviction would have to have occurred within 10 years of the proposed sale of securities (or five years, in the case of the issuer and its predecessors and affiliated issuers).
  • Court injunctions and restraining orders in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries. The injunction or restraining order would have to have occurred within five years of the proposed sale of securities.
  • Final orders from state securities, insurance, banking, savings association or credit union regulators, federal banking agencies or the National Credit Union Administration that bar the issuer from:
    • associating with a regulated entity.
    • Engaging in the business of securities, insurance or banking.
    • Engaging in savings association or credit union activities.
  • Or orders that are based on fraudulent, manipulative or deceptive conduct and are issued within 10 years before the proposed sale of securities.
  • Certain Commission disciplinary orders relating to brokers, dealers, municipal securities dealers, investment companies and investment advisers and their associated persons, which would be disqualifying for as long as the order is in effect;
  • Suspension or expulsion from membership in a “self-regulatory organization” or from association with an SRO member, which would be disqualifying for the period of suspension or expulsion;
  • Commission stop orders and orders suspending the Regulation A exemption issued within five years before the proposed sale of securities; and
  • U.S. Postal Service false representation orders issued within five years before the proposed sale of securities.

Who is covered?

The proposed rule would cover

  • the issuer (i.e. the fund)
  • its predecessors and affiliated issuers
  • Directors, officers, general partners and managing members of the issuer.
  • 10 percent beneficial owners and promoters of the issuer (i.e. the fund manager).
  • Persons compensated for soliciting investors
  • the general partners, directors, officers and managing members of any compensated solicitor (i.e. employees of your placement agents).

The rule is bit fuzzy on how this would apply to fund manager, since it is not legally the issuer. Under the investment advisers registration you already need to disclose criminal activity. That disclosure is broader than what is proposed under the new rule. This is just disclosure, not a bar from use of the offering exemption.

Reasonable Care Exception

The proposed rule would provide an exception from disqualification when the issuer can show it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed.

Paragraph (c)(1) of this section shall not apply:

(i) Upon a showing of good cause and without prejudice to any other action by the Commission, if the Commission determines that it is not necessary under the circumstances that an exemption be denied; or

(ii) If the issuer establishes that it did not know, and in the exercise of reasonable care could not have known, that a disqualification existed under paragraph (c)(1) of this section.

Instruction to paragraph (c)(2)(ii). An issuer will not be able to establish that it has exercised reasonable care unless it has made factual inquiry into whether any disqualifications exist. The nature and scope of the requisite inquiry will vary based on the circumstances of the issuer and the other offering participants.

Here is where compliance steps in. The rule has no explicit record-keeping, reporting or disclosure requirements. But if you want make sure you can take advantage of the “reasonable care exception” you will need to keep records.  It looks like we will need a new form for employees to fill out asking for a disclosure of events under the rule. It also looks like you will need to run criminal background checks on your principals and key employees.

In the release the SEC said: “The steps required would vary with the circumstances, but we anticipate may include such steps as making appropriate inquiry of covered persons and reviewing information on publicly available databases.”

Comments

This is still a proposed rule, but time is short. Under Dodd-Frank, the disqualification rules need to be in place by July 21, 2011. There is time to Submit Comments.

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Dodd’s Solo View on Private Investment Funds

Senator Dodd

Senator Dodd did not forget about private investment funds. Tucked into page 366 of his 1366 page Restoring American Financial Stability Act of 2010 is the Private Fund Investment Advisers Registration Act.

This is largely the same language in the Private Fund Investment Advisers Registration Act of 2009 contained in Dodd’s draft Restoring American Financial Stability Act of 2009. He circulated that draft back in November to start negotiations with Republicans.

Venture Capital Fund Advisers

There is an exemption from registration for the “provision of investment advice relating to a venture capital fund.” The bill gives the SEC the responsibility for defining a “venture capital fund.”

Private Equity Fund Advisers

Unlike the bill passed by the House, Dodd proposes an exemption from registration or reporting requirements with respect to advice given to private equity funds. The SEC is tasked with defining the term “private equity fund.”  Unlike venture capital funds, private equity funds will be subject to SEC record-keeping requirements to the extent the SEC determines it is “necessary and appropriate in the public interest and for the protection of investors.”

State versus Federal Registration of Investment Advisers

Section 410 of the bill raises the federal registration level to $100 million from $25 million. So investment advisers and funds of less than $100 million will be subject to state regulators instead of federal regulators. David Tittsworth, executive director of the Investment Adviser Association, said the change would shift about 4,200 of the 11,000 money managers now registered at the SEC to state regulation.

Accredited Investors

The Dodd bill would change the threshold for “accredited investor.” Currently, the threshold is $200,000 income for a natural person (or $300,000 for a couple) or $1,000,000 in assets. The SEC would have the power to increase those levels  as “appropriate and in the public interest, in light of price inflation since those figures were determined.”

The Comptroller General is also directed to study the financial thresholds for investor eligibility in private funds.

Regulation D Offerings

Separately in the bill, Senator Dodd is proposing to tinker with exemption from registration under Rule 506. Section 926 of his bill, gives the SEC the power to designate certain Rule 506 offerings to not be “covered securities.”  That would get the states more involved in the review and regulation of private offerings, including private fund offerings.

Now What?

This bill still has a long way to go in the Senate. Most reports indicate that private funds are not one of the hotly contested issues in the bill. Assuming the Senate passes the bill, they will need to negotiate the differences between the House and Senate. Assuming it passes, it looks like a big chunk of work would be dropped onto the SEC to define the fund types.

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