As I have blogged about in the past, the JOBS Act will have a significant impact on hedge funds, and in particular smaller hedge funds. As the delayed rule changes become imminent, our firm has noticed a spike in inquiries related to small hedge funds and feeder funds. The JOBS Act is not the only recent congressional act to change the landscape of hedge funds; the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) made a significant impact as well.
In particular, the Dodd-Frank Act eliminated the oft-relied upon exemption from registration for private hedge fund advisers for those advisers with fewer than 15 clients. While eliminating the private adviser exemption, the Dodd-Frank created three new exemptions, which are the operable hedge fund adviser exemptions today. These exemptions are for:
(1) Advisers solely to venture capital funds;
(2) Advisers solely to private funds with less than $150 million in assets under management in the U.S.; and
(3) Certain foreign advisers without a place of business in the U.S.
Moreover, the Dodd-Frank Private Fund Investment Advisers Registration Act of 2010 imposed certain limited filing requirements for those advisors claiming one of the 3 new exemptions.
In this series of blogs, I will provide an overview of each of these exemptions and of the form filing and limited reporting requirements for exempt advisers.
To begin, a reminder of the changes effectuated by and to be effectuated by the JOBS Act, which make the hedge fund adviser exemptions of interest, is in order.
JOBS ACT Changes Affecting General Solicitation and Advertising of Private Offerings
Title II of the JOBS Act requires the SEC to amend Section 4(2) of the Securities Act of 1933 and Regulation D promulgated thereunder, to eliminate the prohibition on general solicitation and general advertising in a Rule 506 offering, so long as all purchasers in such offering are accredited investors. The JOBS Act directs the SEC to make the same amendment to Rule 144A so long as all purchasers in the Rule 144A offering are qualified institutional buyers. Neither a Rule 506 offering nor a Rule 144A offering will be considered a public offering (i.e., will lose its exemption) by virtue of a general solicitation or general advertising so long as the issuer has taken reasonable steps to verify that purchasers are either accredited investors or qualified institutional buyers, respectively.
On August 29, 2012, the SEC published proposed rules eliminating the prohibition against general solicitation and advertising in Rules 506.However, the rules as published failed to delineate specific standards for accredited investor verification, and for that reason and other reasons, met with a great deal of opposition and no further action was taken. It is expected that the SEC will either re-publish new proposed rules or enter an interim final rule.
JOBS ACT Changes to Number of Shareholders Requiring Registration
The JOBS Act amends Section 12(g) and Section 15(d) of the Exchange Act as to threshold shareholder requirements and registration and deregistration requirements such that the shareholder threshold before requiring registration and subsequent reporting with the SEC has been increased from 500 to either (a) 2,000 or more, or (b) 500 or more unaccredited shareholders.
JOBS Act Impact on Hedge Funds
The impact on hedge funds is obvious: They will now be able to advertise for both accredited and qualified institutional investors. Moreover, with the increased number of shareholders allowed before registration, a fund qualified for an exemption under Section 3(c)(7) of the Investment Company Act of 1940 can now advertise and have 1999 accredited shareholders before they would have to register with the SEC and become subject to SEC reporting requirements.
The lift on advertising goes beyond your basic ability to promote on the Internet. It is a lift on the ban for general solicitation, advertising and marketing in general. For example, for the first time, hedge funds will be able to sponsor sporting events and sporting teams.
One caveat of the new rules is that advertising is only allowed where ALL investors are accredited or qualified institutions. Accordingly, a fund with 35 unaccredited investors would not be able to advertise, while those unaccredited investors remain in the fund.
Right now, many hedge funds do not provide any details at all about their investment strategies, historical performance or forecasts of future performance for fear that such open information could be viewed as a solicitation and therefore a violation of the rules. Upon enactment of the new rules, that will all change.
Hedge funds be able to discuss their strategies and performance in depth not only on their website, but on a broader scale, amongst each other. Broker dealers will be able to pitch investors with glossy brochures. Open invitation seminars, together with all the trimmings, will make a comeback.
Of course the SEC and state anti-fraud rules stay in place (and I expect will be beefed up), as do FDA standard truth in advertising rules.
It is widely agreed that these changes will have a dramatic impact on smaller hedge funds.
Introduction to the Private Fund Investment Advisers Registration Act of 2010
The Private Fund Investment Advisers Registration Act of 2010 repealed the prior private fund advisers exemption for those advisers with fewer than 15 clients and who did not advise or manage public hedge funds or investment companies (the “private adviser exemption”).The Act also implemented 3 new exemptions for (1) advisers solely to venture capital funds; (2) advisers solely to private funds with less than $150 million in assets under management in the U.S.; and (3) certain foreign advisers without a place of business in the U.S.
The replacement exemptions also only pertain to private fund advisers. Private funds include hedge funds, private equity funds and other types of pooled investment vehicles that are excluded from the definition of “investment company” under the Investment Company Act of 1940 under either section 3(c) (1) or 3(c) (7).Section 3(c) (1) is available to a fund that does not publicly offer its securities and has 100 or fewer beneficial owners of its securities. Section 3(c) (7) is available to a fund that does not publicly offer its securities and limits the owners of its securities to qualified investors (note that it is funds relying on this exemption which will reap the greatest benefit from the JOBS Act).
In Part II of this series, I will discuss the registration exemption for advisers to venture capital funds.
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