The Deal: SEC Ends Ban on Private Fund Advertising

NEW YORK ( The Deal) -- The Securities and Exchange Commission voted 4-1 on Wednesday, July 10, to move forward with an element of the Jumpstart Our Business Startups Act, eliminating the prohibition against general solicitation and advertising of private placement offerings.

The new regime would affect hedge fund and private equity firms, as well as promoters of private offerings.

SEC Commissioner Luis Aguilar was the sole hold out on the advertising rule. He said the elimination of the solicitation and advertising ban put investors at too much risk for fraud, calling the regulator's action "reckless."

Official adoption of the general solicitation ban and bad-actor rule is subject to a 60-day public comment period and any final revisions by the SEC staff.

The vote on general solicitation has been eagerly anticipated by many market players, since the JOBS Act's passage in April 2012. The law gave the SEC 270 days to write the regulations, and the commission has been criticized for missing the deadline.

The amendment allows general solicitation in offerings conducted under Regulation D of the Securities Act, including sales of securities in private funds and startup companies based on limited information. Sales of securities under Regulation D are limited mostly to accredited investors. The new rule establishes a variety "reasonable steps" for issuers to follow to insure investors are accredited.

The regulator also adopted a rule to disqualify so-called "bad actors" from private placements, in connection with the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The "bad actor" amendment, mandated by the passage in 2010 of the Dodd-Frank Act, allows the commission to disqualify certain felons and others who have been sanctioned by securities regulators from being involved with issuers or promoters of these private offerings.

The SEC has not held a public meeting on the bad actor amendment since January 2012.

While the vote was 5-0 on the bad actor rule, Commissioner Aguilar said the amendment did not go far enough in protecting investors. He objected to a change that makes the definition of a significant shareholder -- who would also be covered by the rule -- too broad, raising the threshold from 10% of any class of securities to 20%.

The most contentious action of the day was the vote to propose an amendment to Regulation D, Form D and Rule 156 to allow the SEC to gather more information in Rule 506 offerings. The amendment would expand the information required to complete a Form D, require the filing of a Form D at least 15 days prior to a securities issue and an amended Form D 30 days after an issue.

Form D filings are required for private placement offerings under Rule 506.

Commissioners Troy Paredes and Daniel Gallagher voted against the amendment, with the majority voting in favor of passage. Paredes said the rule could make it harder for small companies to raise capital.

"The totality of what the commission is proposing would rob the market of its vitality," Gallagher said. He noted that companies used private placements under Regulation D to raise four times the amount of capital that was raised by initial public offerings in 2012.

"This thwarts the purpose of the JOBS Act," Gallagher said. He also said the amendment could stifle capital raising at a time when job creation is critical.

David Pankey, a partner with the law firm McGuire Woods in Washington, said the changes to the proposed rule for ending the ban on general solicitation included a specific safe harbor with a list of steps an issuer can use to verify the accredited status of investors. That was a positive change supported by a large number of market players who submitted comment on the rule when it proposed, Pankey said.

Pankey also said the newly proposed investor protections, which were aimed at increasing the SEC's ability to track Rule 506 offerings in a world where general solicitation will be allowed, will now face a full court press from investor and industry advocates and may not survive intact.

Investor advocates reproached the commissioners for their action on general solicitation.

"With this vote, the Commission has thrown open the doors to mass marketing of hedge funds and other so-called private offerings, knowing full well that it lacks to tools to provide effective market oversight and that the current rules are inadequate to ensure that only those with the financial sophistication to understand the risks and the wealth to withstand potential losses invest in such offerings," Barbara Roper, director of investor protection at the Consumer Federation of America, said in a statement.

Roper said, however, that a legal challenge to the SEC's rules ending the ban on general solicitation is unlikely.

Industry advocates were equally incredulous at the SEC's proposed investor protections.

John Borer, the head of investment banking at Benchmark Co., who also sits on the SEC Advisory Committee on Small and Emerging Companies, said he agrees with Commissioners Paredes and Gallagher that the new investor protections will thwart the intent of the JOBS Act.

"Why are they putting this in there? Just to hire more statisticians to look at information they never even required before?" he said. "Prefiling on a Form D before general solicitation, that was never part of the game before. It costs money, takes time and what's the benefit? Do they have any idea how much this stuff costs?"

Nevertheless, Borer said he was glad the commissioners finally agreed to end the ban on general solicitation. "It makes sense and it made sense a year ago," he said.

Written by Dan Lonkevich And Bill Meagher.

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