Tag: Rule 510T

Filing Form D and General Solicitation

soap box

One of the current issues around a fund manager or company from using advertising as part of its private placement fundraising is the proposed changes to filing requirements for Form D.

Few people I have spoken with actually want to use general solicitation like bulk emails, newspaper ads, or web ads. But they do want to be able to mention fundraising at industry events, advertise the fund manager as a brand, and talk to the media. All of those could be considered general advertising and solicitation or could come close to the line. The SEC has not created a bright line test for when an announcement becomes general and endangers a private placement.

Many people embraced the lifting of the ban on general solicitation and advertising because the fund manager or company could avoid the advertising foot fault of private placement.

The requirement that a firm take reasonable steps to determine if potential investor is accredited is one impediment. For funds with large minimum investment requirements and mostly institutional investors, it’s probably less of an impediment.

The foot-faults under the proposed rule are even greater.

For instance, the proposed rule would require filing of Form D before a general advertisement or solicitation begins. That’s a problem when it’s not clear whether an activity falls under those terms. It’s also a problem if the terms of the offering change over the course of the pre-sale marketing period. Often, a private fund’s terms are not complete during the initial marketing phase.

Even worse, the proposed rule imposes a draconian ban on the use of private placements if you failed to file the Form D before the activity that would be considered general advertising and solicitation.

I agree that not requiring the filing until 15 days after the first sale is not the best method to provide information to investors or regulators. I think the better position is to require the filing 15 days before the first sale.

The proposed rule 510T would also require filing the materials used in general solicitation and advertisements with the SEC. Again, with those terms not well defined it’s hard to know if you have violated the rule. If the materials escape and get published in the media, you’ve potentially blown the private placement and the filing requirement with no ability to cure.

According to Jim Hamilton’s World of Securities Regulation, seven Senators have urged the SEC to adopt the proposed rules to help state securities regulators. Broc Romanek in theCorporateCounsel.net notes that SEC Commissioner Aguilar has weighed in supporting the proposed rules as necessary for investor protection.

Fund managers may be intrigued by the lifting of advertising requirements, they are more likely to cause a foot-fault than staying under the existing private placement regime.

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What to Make of the New Rule 509

509

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.