The Managed Funds Association recently submitted a comment letter to the Securities and Exchange Commission
dated January 6, 2012 requesting the SEC to amend Rule 502(c) of Regulation D
to exempt private funds, such as hedge funds, private equity funds, and venture
capital funds, from the ban on general solicitation and advertising under
Currently under existing law, private funds cannot engage
in any "general solicitation" or "general advertising" in connection with
offers and sales of interests in their funds. This prohibits funds from
engaging in any public advertising and communications about their securities
offerings and requires a "substantial pre-existing relationship" between the
issuer and any offeree. In its letter, the MFA makes the case that changes
in the securities markets and technology have rendered the general solicitation
restrictions of Regulation D, enacted 30 years ago, outdated. In
addition, the MFA argues that the vagueness over what constitutes a general
solicitation, combined with the severe penalties for even an inadvertent
violation creates legal uncertainly for private funds, which inhibits capital
formation. It also makes the argument that allowing general solicitations
for private fund offerings will increase transparency of funds, because they
will be able to publicly publish their returns.
If the MFA proposal were to be adopted, private funds
would be able to engage in public communications and offering activity while
remaining in compliance with Regulation D and corresponding sections of the
Investment Company Act that exempt private funds from investment company
registration if they do not engage in a public offering. This would
certainly ease some of the compliance burdens on private funds.
One question that must be asked is why should this
exemption from the general solicitation requirement apply only to private
funds? Why shouldn't it apply to any Regulation D offering? The
MFA's letter doesn't really answer this point, though it does make a few
arguments in favor of the change that would generally only apply to private
funds. For instance, it argues that the restriction creates an aura of
secrecy that causes people not familiar with securities laws to make negative
inferences about the hedge fund industry. This is certainly true; though
how much harm this actually causes the hedge fund industry is up for debate.
It seems to me that if we've decided that the ban on general
solicitation is outdated, then it should be repealed outright, rather than just
repealed for certain industries.
Another thought I had while reviewing the letter is that
the MFA makes a much better case for exempting so-called "3(c)(7)" funds rather
than "3(c)(1) funds." 3(c)(7) funds are limited to qualified purchasers
who must have over $5 million in investment assets (if an individual) or $25
million in investment (if an institution). Given that there are
relatively few qualified purchasers, repealing the ban on general solicitation
only for offerings targeted towards qualified purchasers would not likely cause
the inundation of investment offers we are likely to see if this was opened up
to all accredited investors.
Therefore, in my view, the best reform that could be
instituted right now would be to allow general solicitation for any private
offering that is offered solely to qualified purchasers (regardless of whether
the offering is for a private fund or some other kind of entity). I also
propose that one additional condition on being exempt from the general
solicitation ban would be that the issuer would be required to document proof
of the qualified purchaser's status by obtaining financial records (rather than
now where the investor can simply represent that he or she is a qualified
purchaser). Such an approach, in my view, may be the best way to balance
the needs of capital formation with investor protection.
 In fact there is
a bill circulating through Congress right now that does repeal the ban on
general solicitation for Regulation D private placements. What comes
of it remains to be seen.
Read more articles by Alexander Davie at Strictly Business, a
business law blog for entrepreneurs, emerging companies, and the investment
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