The Securities and Exchange Commission (SEC) has gotten a tremendous amount of publicity recently for changing its rules to allow fund managers and other issuers to advertise and use general solicitations to raise capital. The discussion of the new rule has generally focused on “private funds” – hedge funds and other funds trading securities – but the new rules also will apply to commodity pools. Here we’ll explain what the SEC did, the current and proposed regulatory hurdles associated with the new advertising rules and whether commodity pool operators (CPOs) can take advantage of those changes (or not).
To summarize, in July 2013, the SEC:
1) adopted final rules required by the Jumpstart Our Business Startups Act (the JOBS Act) to eliminate the ban on general solicitations and advertising by private offerings under Rule 506 of Reg D (which is the exemption relied on by substantially all private funds and commodity pools)
2) prohibited certain felons and other “bad actors” from making offerings under Reg D
3) proposed various new rules which, if adopted, would impose new burdens on persons who wish to advertise their funds.
To be clear, the SEC didn’t want to make these changes, but was compelled to do so by the JOBS Act.
Because Reg D is an SEC rule, why is it important for commodity pool operators (CPO) to understand how it works? Every CPO is selling a security when it sells an interest in a pool to an investor; the interests, shares or units of the pool are themselves securities even if the pool only trades futures. The offer and sale of those pool interests are regulated by the SEC. Generally speaking, offerings of securities have to be registered with the SEC (for example, an IPO) or exempt from this registration. For many decades, SEC rules have exempted “private offerings” from the registration requirement and CPOs and private fund managers have relied on these exemptions to sell their funds. Prior to the recent SEC action, the most basic concept of private offerings had been that the manner of the offering must be “private.” General solicitations, including advertising, were not allowed. The general solicitation ban also restricted the ability of CPOs and private fund managers to discuss their funds in the press or any widely distributed forum – including the manager’s website and websites of third parties.
As required by the JOBS Act, new SEC Rule 506(c) lifts the advertising ban for CPOs and private fund managers willing to comply with its terms. CPOs and private fund managers who do NOT want to publicly solicit or advertise simply have to continue to comply with the “old” Reg D and will not be subject to the provisions of the new Rule 506(c). To advertise, new Rule 506(c) requires:
- All investors in the fund must be accredited investors; and
- The fund manager must take reasonable steps to verify that the investors are accredited.
Rule 506(c) adopts a principles-based “facts and circumstances” approach to determine whether reasonable steps were taken to verify that the purchasers are accredited. It also adds four non-exclusive “safe harbor” methods for determining that a natural person is accredited. Under the principles-based approach, a fund manager can reasonably determine that an investor is accredited based on the facts, e.g., the nature of the investor, the size of the investment, etc.