The MFA commended the SEC for
proposing a framework to implement Section 201 of the Act that permits issuers
to use a variety of methods to verify the status of purchasers. The proposed facts and circumstances analysis
fulfills the SEC’s statutory mandate to determine the methods that an issuer
should use in taking steps to verify the status of investors, said the group, and
provides appropriate investor protection. A one-size-fits-all approach to
verification would be inappropriate for the many different types of
institutions and individuals who will seek to invest in offerings conducted
pursuant to new Rule 506(c).
However, the hedge fund
association urged the SEC to provide issuers with additional legal certainty
when an investment amount is sufficiently high and the purchaser certifies that
it is in fact an accredited investor. In
general, an individual is an accredited investor if he or she has a net worth that
exceeds $1,000,000, and an entity is an accredited investor if it has total
assets that exceed $5,000,000. The MFA
asked the SEC to adopt a safe harbor in the final version of Rule 506(c) deeming
an issuer to have complied with the verification requirement if a purchaser, in
addition to providing certifications that it is an accredited investor and has
not obtained financing for the transaction, meets a certain minimum investment
level that the SEC determines based on these thresholds.
The MFA recommends a minimum
investment level of 50 per cent of the accredited investor net worth or total
asset thresholds, currently $500,000 for an individual, and $2,500,000 for an
entity. This recommendation is based on an
analogous approach to investor qualification that the SEC has used for many
years in the definition of “qualified client” in Rule 205-3 under the Investment
Advisers Act. Under this standard, an investor who has assets under management
with an adviser that are at least half of the value of the net worth threshold
is deemed to meet the qualification requirement. A similar approach is appropriate for the
verification of an accredited investor.
In the alternative, the SEC
should adopt a safe harbor in Rule 506(c) where a purchaser certifies that it
is an accredited investor and did not obtain financing for the transaction, and
invests some minimum amount up to the net worth and total asset thresholds in
the definition of accredited investor.
Any minimum investment amount included in a safe harbor should be
adjusted proportionally in accordance with any future changes to the accredited
investor net worth and total asset thresholds.
If the SEC decides not to include
a safe harbor for a minimum investment, the MFA urged the Commission to describe
in the adopting release how an issuer should incorporate a purchaser’s
investment amount into its analysis of the facts and circumstances of a
transaction. While recognizing that the
proposing release indicates that an issuer conducting an offering with a high
minimum investment may not need to take additional verification steps other
than to confirm that the investment is not being financed by the issuer or by a
third party, the MFA noted that an issuer would not be able to determine
independently whether an investment is financed by a third party.
Rather, an issuer could
confirm that the issuer itself has not financed the transaction, and obtain a certification
from the purchaser that it has not obtained financing for the transaction. Such
a process, posited the MFA, together with a sufficiently high investment
minimum and a certification from the purchaser that it is an accredited
investor should fulfill the requirement that an issuer take reasonable steps to
verify the status of the purchaser.
The hedge fund association
also asked the SEC to confirm that private funds and other issuers with
existing investors who are not accredited investors will be able to rely on new
Rule 506(c) by complying with the applicable requirements with respect to
future investments in the private fund. This approach is consistent with the
language and underlying policy of the JOBS Act.
Section 201(a) instructs the
SEC to eliminate the ban on general solicitation for offers and sales of
securities made pursuant to Rule 506, provided that all purchasers of the
securities are accredited investors. Thus,
reasoned the MFA, the requirement that all purchasers are accredited investors
should apply only to future sales made pursuant to Rule 506(c) and should not
require an issuer to either redeem or buy out existing investors, or incur the
burdens of organizing an entirely new private fund.
Including a “grandfathering”
provision for existing investors is also consistent with the goal of Section
201(a) to ensure that any investor who may have learned about the issuer
through general solicitation or advertising is an accredited investor. Issuers that currently conduct offerings
under Rule 506, such as private funds, are prohibited from engaging in general
solicitation. As a result, existing
investors have not been subject to any general solicitation activities, and
should be able to maintain their investments in private funds that rely on Rule
506(c) in future offerings.
Finally, while the MFA supports
the SEC proposal that an issuer indicate on Form D whether it is relying on
Rule 506(b) or Rule 506(c), the group believes that such an indication may be
of limited use to the SEC in monitoring general solicitation by private
funds. Given the uncertainty about what
activities may be deemed a general solicitation, the MFA expects that many
private funds will indicate on Form D, based on the advice
of outside counsel, that they
are relying on Rule 506(c) even if they do not intend to engage in actual
solicitation activities. Some fund
managers, for example, may rely on Rule 506(c) in order to respond to media
inquiries or correct inaccurate information about a private fund, which may or
may not be deemed a general solicitation, depending on the facts and
circumstances.