Written by: Jay Gould
When can private fund managers start posting performance numbers on their websites and sponsoring the Super Bowl? Not yet, according to Senator Carl Levin (D-MI) in letters dated October 5,2012 and October 12, 2012, (the “Levin Letters”) rebuking the SEC for having missed the point of the legislation in the SEC rulemaking process. As you recall, on August 29, 2012, the SEC proposed rules pursuant to Section 201 of the Jumpstart our Business Startups Act (“JOBS Act”) that, if adopted in final form, would allow private issuers, including private funds, to generally solicit and advertise as long as the investors are all “accredited investors.”
Of most importance to hedge fund and private equity fund managers that have been anticipating a more relaxed and flexible approach of communicating with the public and soliciting new investors, the Levin Letters flatly accuse the SEC of failing to grasp the scope of the JOBS Act in applying it to private investment vehicles. According to Levin, the SEC should “distinguish between issuers that engage in operational businesses and those that are merely investment vehicles.” The October 12 letter further advises the SEC that “[c]ongress did not contemplate removing the general solicitation ban – without retaining any limitations on forms of solicitation – for private investment vehicles. Indeed, no argument was made during the debate of the bill that the objective was to ease the capital aggregation process for private investment vehicles. The words “hedge fund,” “private fund,” or “investment vehicle” were not used either during the committee or floor debate in the House of Representatives. Nor did the Senate engage in any debate relating to removing these advertising and marketing restrictions completely from private investment vehicles.”
According to the Levin staffer who is responsible for this area of the Senator’s legislative initiatives, we should no longer expect that the SEC will adopt the rules as proposed. The SEC must propose new rules that more accurately reflect the intent of Congress and not simply abdicate regulatory authority over the use of general advertising and solicitation by private funds, the Investment Fund Law Blog was told by Levin’s office.
This SEC mulligan may very well put back into play many of the criticisms of the JOBS Act that were expressed in the comment period after the JOBS Act was first signed into law. As you may recall, on May 21, 2012, the Investment Company Institute (the “ICI”) submitted a comment letter to the SEC regarding Section 201 of the JOBS Act in which the ICI encouraged the SEC to, among other things, adopt advertising rules for private funds that are at least as restrictive as those that apply to registered mutual funds, raise the income and net worth standards in the definition of “accredited investor,” and prohibit or limit performance advertising by hedge funds until the SEC has studied the implications of such advertising for 60 years. In a follow up letter to the SEC on August 17, 2012, the ICI, citing press reports and rumors, implored the SEC to not adopt “interim rules” pursuant to Section 201. Rather, the ICI suggested, full notice and comment should be employed in this rulemaking process so that the SEC might fully observe its fundamental mandate to protect investors. It should be noted that the SEC began accepting public comments on all aspects of the JOBS Act shortly after the legislation became law on April 5, 2012. The law itself requires the SEC to adopt rules pursuant to Section 201 within 90 days of the signing of the legislation, a time frame that, quite obviously, was not met.
The Levin Letters further admonished the SEC to establish “methods” for determining whether an investor meets the “accredited investor” standard. The rule proposal provided only that an issuer must take “reasonable steps” to determine accredited status, and provided significant flexibility for issuers to determine the appropriate level of due diligence in order to verify status. The Levin Letters requested that the SEC go back to the drafting table and come up with a new proposal that requires “common sense” documentation and/or verification practices and procedures. If, as Levin’s office suggests, the SEC does re-propose rules as a result of this criticism, it could result in issuers being required to follow definitive verification standards, such as obtaining an income statement, balance sheet, or bank or brokerage statements from investors.
It is possible that the last chapter of the JOBS Act rules regarding general solicitation may not yet be written. In the meantime, private fund managers should continue observing the current ban on general solicitation and advertising and put on hold those plans to post their performance returns on the back of Serena Williams’ tennis togs.