The recently enacted Jumpstart Our Business Startups Act, or the “JOBS Act,” will change the way private funds solicit and secure subscription commitments from investors and raise capital for portfolio companies by permitting general solicitation and general advertising in Regulation D private placements (offerings to accredited investors) and in Rule 144A offerings (offerings to qualified institutional buyers). Private funds also should benefit from the provisions of the JOBS Act increasing the number of stockholders of record a company may have before being required to register with the SEC and exempting certain persons from registering as a broker-dealer when maintaining a platform to conduct private placements. The JOBS Act will also make it easier for certain portfolio companies of private funds to more easily offer securities to the public markets.
Change to General Solicitation and Advertising Rules
The SEC has been directed to revise its rules for offerings of securities under Section 506 of Regulation D to remove the prohibition under Section 502 of Regulation D on general solicitation and general advertising of offers and sales of securities provided: (1) all purchasers of securities in the offering are accredited investors and (2) the issuer of securities takes reasonable steps to verify that purchasers are accredited investors, using methods to be determined by the SEC. Note that presently, in determining the status of offerees and purchasers of securities under Regulation D, issuers must “reasonably believe” each offeree and purchaser is an accredited investor. In the future, issuers will be required to verify purchasers meet the accredited investors standard based on criteria and processes established by the SEC.
The SEC also has been directed to revise its rules to provide that securities sold under Rule 144A may be offered to persons other than “qualified institutional buyers,” including by means of general solicitation or general advertising, provided that securities are sold only to persons that the seller, and any person acting on its behalf, reasonably believes is a qualified institutional buyer.
Presently, in order for an offering of interests in a private fund to qualify as a private offering exempt from the general requirement that offers and sales of securities must be registered with the SEC, the interests may not be offered publicly and are sold in private placements. Rule 506 under Regulation D provides a safe-harbor under Section 4(2) of the Securities Act of 1933, as amended (the Securities Act), for offers and sales to accredited investors. However, the offers and sales may not be made by any form of general solicitation or general advertising, thus prohibiting communication through advertising in newspapers, magazines or similar publications, radio and television broadcasts and public seminars.
Counsel to private funds often are called upon to review communications with the media by representatives of private funds to determine whether the rule on general solicitation or advertising has been breached. Many counsel also strongly discouraged clients from appearing on speaker panels while their private funds were being marketed. In some cases, offerings have been delayed on account of overzealous public communications. The JOBS Act will eliminate those concerns and allow for public advertising of private fund interests so long as actual sales are only made to accredited investors. Furthermore, broker-dealers and placement agents need not have a pre-existing relationship with an offeree or knowledge that the offeree is an accredited investor, before delivering private placement materials and soliciting a sale of private fund interests. Portfolio companies of private funds will also benefit from these changes.
Change Under Investment Company Act
In addition to the present restrictions on general solicitation and advertising under the Securities Act, private funds also are subject to limitations on public offering of interests under the Investment Company Act of 1940, as amended (the Investment Company Act).
A private fund that relies on Section 3(c)(1) of the Investment Company Act, for funds with fewer than 100 beneficial owners, or Section (3(c)(7) of the Investment Company Act, for funds with only qualified purchasers, to avoid being deemed an “investment company” is required not to be making and not to presently propose to make a public offering of its securities. The JOBS Act clarifies that offers and sales of private fund interests exempt under Rule 506 of Regulation D, as modified (see above), will not be deemed to be public offerings under Federal securities laws as a result of general advertising or general solicitation.
Change to Increase Number of Stockholders of Record Prior to Required Registration with the SEC
Section 12(g) of the Securities Exchange Act of 1934, as amended, has been amended to loosen the requirement for when an issuer must register a class of equity securities as follows: Registration is required if on the last day of the preceding fiscal year the issuer has total assets exceeding $10 million and a class of equity securities “held of record,” by either (1) 2,000 persons or (2) 500 persons who are not accredited investors. The JOBS Act also excludes from the definition “held of record” securities held by persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of Section 5 of the Securities Act and requires the SEC to adopt safe-harbor provisions issuers can follow to determine whether holders of their securities received them pursuant to an employee compensation plan in transactions exempted from registration requirements of Section 5 of the Securities Act.
Change in Required Broker-Dealer Registration for Persons Maintaining a Platform to Conduct Private Placements
A person who meets the conditions listed below will not be required to register as a broker-dealer if it assists in the offer and sale of securities under Rule 506, as revised, solely because (i) that person maintains a platform permitting the offer and sale, negotiation or general solicitation or general advertisement of securities, (ii) that person coinvests in such securities, or (iii) that person provides ancillary services with respect to those securities. “Ancillary Services” means the provision of due diligence services, so long as those services do not include, for separate compensation, investment advice or recommendations to issuers or investors and the provision of standardized documents to issuers and investors, so long as the person does not negotiate the terms of issuance for and on behalf of third parties and issuers are not required to use the standardized documents as a condition of using the service. It is a condition, however, that such person and each associated person (i) receive no compensation in connection with the purchase or sale of such security (ii) do not have possession of customer funds or securities in connection with such purchase or sale, and (iii) not be subject to statutory disqualification.
What Has Not Changed?
- The change to the rules on general solicitation and general advertising apply only to private placements made under the Rule 506 of Regulation D safe-harbor for private offerings. Private placements under Section 4(2) of the Securities Act that do not meet the Rule 506 requirements will not benefit from any modification of the restrictions on general advertising and general solicitation under Rule 506.
- Regulation S contains a restriction on “directed selling efforts” which includes placing an advertisement in a publication “with a general circulation in the United States that refers to the offering of securities being made in reliance upon this Regulation S.” The SEC is not required to provide relief from the restrictions on general advertising and solicitation under Regulation S and so issuers will have to consider any public advertising in an offering that includes a Regulation S component.
- Anti-fraud rules remain in effect and must be complied with in offerings under the revised rules for general solicitation and general advertising.
Portfolio Company IPOs
Certain provisions of the JOBS Act should be helpful to private equity funds whose portfolio companies that qualify as emerging growth companies are contemplating initial public offerings. An emerging growth company is defined as an issuer whose revenues were less than $1.0 billion in its last fiscal year. In particular, the JOBS Act’s “testing the waters” provision and the ability to submit to the SEC a draft IPO registration statement and amendments of an emerging growth company on a confidential basis may encourage private equity firms to more seriously consider initial public offerings for their portfolio emerging growth companies. Specifically, the testing the waters provision allows an emerging growth company and its investment bankers to contact accredited institutional investors to assess their appetites for investing in the potential IPO of such company. The confidential filing provision allows an emerging growth company to submit its IPO registration statement and amendments to the SEC on a confidential basis provided that it publicly files such registration statement and amendments with the SEC 21 days prior to the company’s official road show. The combination of these provisions should encourage private equity funds to commence the IPO process for their eligible portfolio companies. First, with the information learned in the “testing the waters” process, private equity funds and their portfolio companies will get a better sense of whether the IPO might be successful prior to committing to the full expense of the IPO process, as well as being able to continually assess accredited institutional investors’ appetites for the offering throughout the SEC registration process. Second, the confidential submission process allows companies to commence and continue through a large part of the IPO process with the SEC without the general public being aware of the IPO attempt, thereby avoiding the public embarrassment or taint if the IPO cannot be completed.