On December 13, the SEC voted unanimously to propose new rules and amendments to existing rules directed at private fund advisers and fund investors. As explained in more detail below, the proposed rules and amendments would create a new anti-fraud provision under the Advisers Act and create a new category of accredited investor under Regulation D of the Securities Act. The SEC is proposing these rules and amendments in response to the Court of Appeals decision in Goldstein vs. SEC. Thus far, the SEC has released a brief press release describing the actions it took. (See www.sec.gov/news/press/2006/2006-208.htm)
Below is a discussion of the proposed new rules and amendments based on the SEC press release and comments made by the SEC Commissioners and staff during the meeting on December 13. We understand that the proposed new rules and amendments and the related proposing release, which will contain critical details, have not been released to the public because they have not been finalized. We intend to update the information in this client alert after these items are made public.
A. Antifraud Provision under the Investment Advisers Act of 1940
The SEC proposed a new anti-fraud rule under Section 206(4) of the Advisers Act intended to clarify that private fund advisers may not defraud fund investors. More specifically, the proposed rule would make it a fraudulent, deceptive or manipulative act in violation of the Advisers Act for an investment adviser to a pooled investment vehicle to make false or misleading statements, to fail to disclose a material fact or to otherwise defraud investors or prospective investors in that vehicle. The rule would apply to both registered and unregistered investment advisers. In addition, the term “pooled investment vehicle” would include an investment company and any company that would be an investment company but for the exclusions in Section 3(c)(1) or 3(c)(7) of the Investment Company Act. The rule would not distinguish between private funds based on their investment strategies, type of fund, or any lock up period. Moreover, the rule would not be limited to fraud in connection with the purchase or sale of interests in a private fund. Finally, the proposed new rule would not create a private right of action.
B. Revisions to the Accredited Investor Standard
The SEC also proposed revisions to rules under the Securities Act that will essentially revise the definition of an “accredited investor” for natural persons investing in a private fund by creating a new category of accredited investor. The proposed amendments will not raise the income and net worth standards contained in Rule 501(a) of Regulation D. Instead, the proposed amendments will add an additional criterion. Specifically, a natural person “accredited investor” in a private fund must continue to meet the income or net worth standards and will also need to own at least $2.5 million in investment assets. According to the SEC staff, the investment asset minimum will be based on a similar requirement for “qualified purchasers” under Section 3(c)(7). This additional criterion is intended to ensure that a potential investor in a private fund has the investment experience necessary to understand the risks associated with making an investment in a private fund.
During the course of the SEC meeting on December 13, SEC Commissioners and the staff provided the following additional information. The $2.5 million standard will be proposed to adjust for increases in net worth due to inflation (including the rise in home values) so that approximately the same percent of the population who could invest in a private fund in 1982, the year the current accredited investor standard was established, will be able to invest in private funds under the proposed amendments. In addition, the SEC would reset the minimum investment asset standard in April 2012 and every five years thereafter. The minimum investment asset test will be applied only at the time an investment is made.
The new category of “accredited investor” for private funds would not apply to venture capital funds. The SEC staff apparently believes that venture capital funds play a different role in the economy’s capital system and do not pose the same level of risk for investors (although Commissioner Atkins questioned these assumptions as a basis for the proposed carve out). Neither the Commissioners nor the SEC staff explained how the revised accredited investor standard would distinguish a venture capital fund from other types of private funds (including private equity funds).
The SEC staff currently is in the process of revising Form D, which is filed with the SEC in connection with the private offering of securities. Apparently, the revised Form D will include specific items related to private funds, such as whether an offering of interests in a private investment fund is being made pursuant to Section 3(c)(1) or 3(c)(7). In addition, Form D will be modified so that it will be submitted to the SEC electronically.
Finally, the press release does not address the issue of minimum standards for investments by an adviser’s employees nor did the Commissioners or SEC staff have a detailed discussion that clarified this issue. Accordingly, it will be necessary to review the actual proposed rule and proposing release to understand the SEC’s position on this issue. The SEC staff, however, clarified that current investors in a private investment fund will be “grandfathered” in and hence not be subject to the proposed accredited investor revision except with regard to future investments.
Comments on the proposed new rules and amendments will be due 60 days after their publication in the Federal Register.