Sponsors criticize SEC’s proposed solicitation rules

  • Proposed regulations relate to JOBS Act
  • Adapting mutual fund rules for private funds
  • “A passive-aggressive regulatory regime”

The rules on solicitation took effect on Sept. 23, allowing buyout fund managers to use advertising and public relations to get the word out about their funds, provided they ensure their actual investors are accredited. On the same day the comment period closed on related proposals that would require sponsors to file Form Ds in advance of any general solicitation and make changes to those filings as business conditions changes. (It is not clear if the Form Ds would be made public, but the presumption is that they would not be.)

Commenters complained about the additional red tape. But they focused most of their criticism on proposed federal anti-fraud provisions that any advertising or promotion stick closely to what is revealed in written PPMs and other documentation, exposing sponsors to penalties if they went beyond that. Critics expressed concern that the proposed rules could have exactly the opposite effect from what Congress directed in the 2012 Jumpstart Our Business Startups Act.

Specifically, critics say the new proposals would require fund marketers to stick closely to the content and language of the written offering circulars, perhaps even if they do not market their funds broadly. That language, industry advocates say, was adapted from anti-fraud rules that were intended for mutual funds sold to retail investors, not the accredited investors in private equity that are expected to do more extensive due diligence before committing capital to a fund.

“They’re setting it up so it’s nearly impossible to do general solicitation,” said Brett Palmer, the president of the Small Business Investors Alliance, which represents small business investment companies, a special category of investors licensed by the Small Business Administration. “Some people I’ve talked to say it runs directly contrary to congressional intent.”

“The final general solicitation rules follow the intent of Congress and permit general solicitations in private placements with more than appropriate safeguards,” said Jason Mulvihill, general counsel of the Private Equity Growth Capital Council, which represents buyout shops in Washington, D.C. “In contrast, the proposed rules could work to undercut the purpose of the JOBS Act by adding additional, unnecessary burdens on investment advisers.”

Some congressional leaders appear to agree, at least when it comes to other regulations. Two key House Republicans—Jeb Hensarling, the chairman of the House Financial Services Committee, and Scott Garrett, who chairs the capital markets subcommittee—formally asked the SEC in September to justify the stringent new rules for private equity funds in a letter sent to Securities and Exchange Commission Chair Mary Jo White.

The pair argued that sophisticated investors need less protection, sister news service Reuters reported. “For these advisers, the SEC examination process has proven to be burdensome, costly, inefficient and inflexible,” Hensarling and Garrett wrote. “Subjecting this set of advisers to the examination process does not appreciably further the goals of investor protection or financial stability.”

However, in a political climate characterized by extreme partisanship, it is unclear how much influence elected officials can exert over executive agencies. Some Washington watchers believe the SEC doubted the wisdom of relaxing investor protections in the first place, but then, faced with the demands of the JOBS Act to enable general solicitation, took advantage of the divided Congress to write rules that would continue to be as restrictive as possible.

The complaints concern not only fund managers, but also private companies. Fred Wilson, a principal of Union Square Ventures, argued that start-ups themselves might also run afoul the new rules while doing private fundraising.

“It is my opinion, and that of those who we do business with, including our securities lawyers, that these proposed rules effectively make general solicitation a non-starter for startup companies,” Wilson wrote in a comment letter. “If the SEC’s intention, with these proposed additional rules, is to neuter general solicitation to the point that it is legal but nobody avails themselves of it, they will succeed.”

“The rule as it is written would trigger all sorts of headaches,” said Palmer of the SBIA. “It’s kind of a passive-aggressive regulatory regime they’re proposing.”

Fund managers contacted by Buyouts have generally indicated little interest in taking advantage of the general solicitation rules, saying that they prefer to deal with the large institutional investors, so they will not face the responsibility of confirming whether smaller investors are in fact accredited to participate in their funds. However, mega-firms with strong brand names to promote and start-up firms trying to establish their brands are expected to avail themselves of the opportunity to advertise and promote themselves through mass media.