December 2013
JONES DAY
COMMENTARY
SEC Lifts Long-Time Ban on Advertising by Hedge
Funds, Private Equity Funds, and Other Private
Investment Vehicles
O n J ul y 10 , t h e U . S . S e c u ri t i e s a n d E xc h a n g e
through advertisements, articles, notices, or other
Commission (“ SEC ”) adopted final rules under
communications published in any newspaper, maga-
S e c tion 201(a) of the J ump s t ar t O ur B us ine s s
zine, or similar media broadcast over television, the
Startups Act (the “JOBS Act ”) removing the ban
radio, or the internet.
against general solicitation and general advertising in
private offerings made in reliance on Rule 144A and
In addition, the SEC adopted new Rules 506(d) and
Rule 506 of Regulation D under the U.S. Securities
(e) and changes to Form D, which make all Rule 506
Act of 1933 (the “Securities
Act”).1
The new rules went
offerings subject to certain “bad actor” disqualifica-
into effect on September 23. 2
tion, disclosure, and certificate requirements.
The amendments to Rule 506 permit private issu-
This Commentary focuses on the elimination of the
ers—including hedge funds, private equity funds,
long-time prohibition against general solicitation and
venture capital funds, and other private invest-
general advertising on Rule 506 offerings by hedge
ment vehicles—to use general solicitation and gen-
funds, private equity funds, and other alternative
eral advertising in a Rule 506 private placement, as
investment funds. In short, although a much broader
long as all purchasers are accredited investors and
array of marketing tools is now available to be used
the issuer takes “reasonable steps” to verify that
by private fund issuers, before engaging in general
the purchasers are accredited investors. Under new
solicitation in a Rule 506(c) offering, private funds
Rule 506(c), private funds may now solicit investors
and their investment advisers will need to reexamine
© 2013 Jones Day. All rights reserved. Printed in the U.S.A.
gence requirements and consider whether engaging in
Reasonable Steps to Verify Accredited
Investor Status
general solicitation may conflict with other regulatory restric-
The verification requirement is a “principles-based” condi-
tions to which the fund is subject (such as CFTC regulations,
tion that requires the issuer to take reasonable steps to ver-
the Investment Advisers Act, and any non-U.S. restrictions on
ify the accredited investor status of purchasers. Whether the
advertising applicable to the fund).
steps taken were in fact reasonable is an “objective deter-
their policies, procedures, and customary transaction documents to ensure compliance with the heightened due dili-
mination … in the context of the particular facts and circumstances of each purchaser and transaction.”4
Overview of Rule 506
Under the principles-based approach, issuers should con-
Most private funds rely on the private placement exemption
sider a number of interconnected factors. The more that
made available by Rule 506 to avoid the registration require-
the relevant facts and circumstances make it likely that a
ments of Section 5 of the Securities Act with respect to offer-
purchaser is an accredited investor, the fewer verification
ings in the United States. Rule 506 permits issuers to raise
steps that will be required, and vice versa. 5 The informa-
an unlimited amount of capital in private offerings sold to an
tion gained by looking at the following factors would help an
unlimited number of accredited investors and up to 35 nonac-
issuer assess the reasonable likelihood that a purchaser is
credited investors. Any form of general solicitation or general
an accredited investor and whether additional steps might
advertising was explicitly prohibited under the pre-amend-
be necessary:
ment version of Rule 506 (the “Old Rule”).3 This restriction had
generally been interpreted broadly to prohibit, among other
The Nature of the Purchaser and Type of Accredited
things, the use of publicly available websites, media broad-
Investor that the Purchaser Claims To Be. Taking reason-
casts (such as radio and television advertisements), mass
able steps to verify accredited investor status may differ with
email campaigns, and public seminars or meetings as part of
respect to different types of investors, such as corporations
an issuer’s capital-raising activities.
as compared to natural persons. The definition of “accredited investor” in Rule 501(a) includes eight enumerated categories of individuals or entities. Some purchasers may be
Amendments to Rule 506
accredited investors based on their status alone (e.g., an
The amendments add to Rule 506 a new paragraph (c),
investment company registered under the U.S. Investment
which permits the use of general solicitation and general
Company Act of 1940 (the “Investment Company Act”) or
advertising in connection with an offering of securities under
a broker or dealer registered under the U.S. Securities
Rule 506, provided that:
Exchange Act of 1934 (the “Exchange Act”)), while others
satisfy the standard by virtue of their status and their total
The issuer takes “reasonable steps to verify” that the pur-
assets taken together (e.g., certain entities with total assets
chasers are accredited investors;
in excess of $5 million).
• All purchasers of the securities are “accredited investors”
The Amount and Type of Information that the Issuer Has
(i.e., all of the purchasers fall into one of the categories set
About the Purchaser. Examples of the types of information
forth in Rule 501(a), or the issuer reasonably believes that
that issuers could review include publicly available informa-
all of the purchasers fall into one of such categories); and
tion in filings with federal, state, or local regulatory bodies or
information available through a third party, such as a brokerdealer, accountant, or attorney.
• All terms and conditions of Rule 501, 502(a), and 502(d),
which set forth definitions, general conditions, and limitations on resale, are satisfied.
2
The Nature and Terms of the Offering. The issuer should
• Third-Party Verification. Receiving written confirmation
consider the manner in which the purchaser was solicited to
from an SEC-registered broker–dealer, SEC-registered
participate in the offering. The more public the method (e.g.,
investment adviser, licensed attorney, or certified public
a publicly available website, social media, or mass email),
accountant7 that such entity or person has taken reason-
the more likely additional verification steps will be required.
able steps to verify the purchaser’s accredited status; and
It is important to note that the issuer must take reasonable
• Verification by Existing Relationship. With respect to a
steps to verify accredited investor status; an issuer will not
purchaser who invested in a Rule 506(b) offering as an
be deemed to have complied with Rule 506(c) simply on
accredited investor prior to the effective date of Rule
the grounds that the purchasers ultimately were all accred-
506(c), remains an investor, and intends to invest in a Rule
ited investors. In the context of a Rule 506(c) offering, the
506(c) offering by the same issuer, receiving a certifica-
practice of accepting self-certification by an investor (i.e., a
tion from the purchaser that he or she qualifies as an
checked box on an investor questionnaire or subscription
accredited investor.
agreement) will not be sufficient on its own to demonstrate
that reasonable steps have been taken to verify accredited
Issuers and investment advisers that intend to conduct a
investor status.6
private fund offering in reliance on Rule 506(c) should make
certain that they have due diligence and recordkeeping policies and procedures in place that ensure compliance with
A Nonexclusive List of Methods to Verify
Accredited Investor Status of Natural
Persons
the verification required under the new rule.
Reasonable Belief Standard
In order to address industry requests that Rule 506(c)
The “reasonable belief” standard in the definition of accred-
include some element of certainty with respect to verifica-
ited investor (i.e., that an accredited investor is a person who
tion methodologies, the SEC provided a nonexclusive list of
meets one of the enumerated categories, or who the issuer
methods that an issuer may use to satisfy the verification
reasonably believes meets one of the enumerated catego-
requirement for a purchaser who is a natural person. These
ries) is unchanged by the amendment to Rule 506. As long as
methods include:
an issuer takes reasonable steps to verify that a purchaser is
an accredited investor and has a reasonable belief that the
• Verification by Net Income. Reviewing copies of any IRS
purchaser is an accredited investor, the issuer would not lose
form that reports the income of the purchaser together with
the ability to rely on Rule 506(c) if it is later discovered that
a written representation that the purchaser expects to con-
the purchaser is not in fact an accredited investor. On the
tinue to earn the necessary income in the current year;
other hand, an issuer that fails to take reasonable steps to
verify accredited investor status will lose the benefit of Rule
• Verification by Net Worth. Reviewing copies of bank and
506(c) even if all purchasers are accredited investors.8
brokerage, certificate of deposit, tax assessment, and
appraisal reports issued by independent third parties
as evidence of the purchaser’s assets, and a consumer
“Bad Actor” Disqualification and Revised
Form D
credit report as evidence of the purchaser’s indebtedness
in each case dated within the prior three months, together
with a written representation from the purchaser that all
The SEC adopted new Rules 506(d) and (e) and changes to
liabilities necessary to make a determination of net worth
Form D, which make all Rule 506 offerings subject to cer-
have been disclosed;
tain “bad actor” disqualification, disclosure, and certificate
requirements. Generally, where issuers are associated with
3
Investment Advisers Act
events specified by Congress as indicators of financial or
disclosure fraud or misconduct, the use of Rule 506 will be
Investment advisers that are registered with the SEC must
prohibited (or, with respect to pre-September 23 “bad actor”
continue to comply with rules relating to advertising under
events, permitted only with disclosure of such bad acts).
the U.S. Investment Advisers Act of 1940 (the “Advisers Act”).
Form D was amended to add a check box for issuers to indi-
For example, a registered investment adviser is limited in
cate whether they are relying on Rule 506(c). The SEC noted
its ability to use marketing materials that refer to any tes-
that this would give it an opportunity to monitor the use of
timonial concerning the investment adviser or that refer to
general solicitation in private offerings and would assist it in
its past specific investment recommendations. Investment
evaluating the effectiveness of various accredited investor
advisers are also limited in the way that they may present
verification practices.
a track record. Adequate disclosures are typically required
in order to ensure that information will not be deemed to be
The Impact of Rule 506(c) on Private
Funds
misleading, inaccurate, or incomplete.
Amended Rule 506 substantially increases the types of per-
exemptions from Advisers Act registration, such as the for-
mitted fundraising activities of private funds. Under Rule
eign private adviser exemption, it is important to note that
506(c), funds are now permitted to engage in all forms of
the SEC did not indicate whether it would view an invest-
communication with prospective investors, including forms
ment adviser to a private fund that conducts an offering
of communication traditionally viewed as general solicita-
under Rule 506(c) as not “holding itself out” as an invest-
tion, as long as (i) the only investors actually admitted into
ment adviser, which is a key condition required in order to
the fund qualify as “accredited investors” or who the fund
take advantage of the exemption.
For investment advisers that take advantage of certain
reasonably believes would so qualify, and (ii) the fund takes
reasonable steps to verify the accredited investor status of
CFTC
each of the investors admitted to the fund.
The use of general solicitation or general advertising
Most private funds rely on the Section 3(c)(1) or 3(c)(7) 9
may affect the availability of certain exemptions under
exclusions under the Investment Company Act to avoid
rules promulgated by the Commodity Futures Trading
being deemed investment companies. Both Section 3(c)
Commission (“CFTC”), including the de minimis exemp-
(1) and 3(c)(7) require that the fund is not making and does
tion from registration as a commodity pool operator under
not propose to make a “public offering” of its securities. The
CFTC Rule 4.13(a)(3). The de minimis exemption requires
SEC has expressly confirmed that an offering made pursu-
that interests in each applicable fund be “offered and
ant to Rule 506(c) will not constitute a public offering for pur-
sold without marketing to the public in the United States.”
poses of Sections 3(c)(1) and 3(c)(7).10
Without a contrary holding by the CFTC, it appears that
private funds using general solicitation may not be able to
However, private funds and their investment advisers will
rely on the Rule 4.13(a)(3) exemption. CFTC Rule 4.7, which
need to consider whether engaging in general solicitation
provides relief from certain regulatory requirements for
may conflict with other regulatory restrictions to which the
CFTC-registered commodity pool operators, also includes
fund is subject. Outlined below are several of the key factors
a restriction against general solicitation.
to be considered in making such a determination.
4
Anti-Fraud Rules and Foreign Publicity
Restrictions
Conclusion
Marketing materials used to solicit prospective investors
eral advertising under Rule 506, the SEC has opened up
remain subject to the anti-fraud rules under the U.S. federal
opportunities for participants in the private fund industry
securities laws, including Rule 10b-5 under the Exchange
to expand their investor base and grow their businesses.
Act and Rule 206(4)-8 under the Advisers Act. In addition,
However, before moving forward aggressively, fund manag-
many non-U.S. jurisdictions have their own publicity rules
ers should ensure that appropriate controls, policies, and
and restrictions in connection with an offering that must be
procedures are in place to mitigate the potential compliance
observed if the fund is marketed in those jurisdictions.
risks involved. Private funds intending to engage in gen-
By lifting the long-time ban on general solicitation and gen-
eral solicitation will need to reexamine their due diligence
procedures and customary transaction documents, which,
State Registration as an Investment
Adviser
for many, up until now have generally not included provi-
By lifting the ban on general solicitation, Rule 506(c) will allow
managers must also consider any applicable compliance
contact with potential investors through unblocked internet
obligations under other laws and regulations, including the
websites, which means that private funds could potentially
Advisers Act, the rules promulgated by the CFTC, and state
solicit investors in many different states within the United
and non-U.S. laws, which may prohibit advertising under rel-
States. Commonly referred to as the “de minimis” exemption,
evant exemptions.
sions that contemplate general solicitation or the robust
verification procedures required under the new rule. Fund
most states have a maximum number of clients an investment adviser (who does not have an office in the state or is
not otherwise registered with the SEC) may have without
being required to register in that state. The number varies
from state to state. In many states the number is five or fewer,
in other states the number is six, while a few state statutes
have no de minimis exemption and require firms to register in
the state if they have just one client in the state. Furthermore,
there are some states with more stringent rules requiring that
the adviser not “hold itself out to the public” as an investment
adviser to qualify for the de minimis exemption.
Given the varying rules and regulations across the states,
investment advisers that plan to use Rule 506(c) to engage
in general solicitation of investors should consult with counsel with respect to the laws in the states in which they will
solicit potential investors to determine whether they must
register as an investment adviser. This is particularly important if the investment adviser intends to solicit investors on
the internet, where the adviser may be deemed to be holding itself out to the public as an investment adviser.
5
Lawyer Contacts
Endnotes
For further information, please contact your principal Firm
representative or one of the lawyers listed below. General
email messages may be sent using our “Contact Us” form,
which can be found at www.jonesday.com.
S. Wade Angus
Alex Gendzier
New York
New York
+1.212.326.3755
+1.212.326.7821
São Paulo
agendzier@jonesday.com
+55.11.3018.3914
swangus@jonesday.com
Mitch Gibbons
Houston
Dennis Barsky
+1.832.239.3788
Singapore
mitchgibbons@jonesday.com
Carolyn McNabb
Singapore
Joseph E. Bauerschmidt
+65.6233.5983
Singapore
cmcnabb@jonesday.com
+65.6233.5533
jbauerschmidt@jonesday.com
Available at http://www.sec.gov/rules/final/2013/33-9415.pdf
(the “Adopting Release”).
2 Revised Rule 144A permits a seller to rely on Rule 144A even
if the securities are offered to non-Qualified Institutional
Buyers (“QIBs”), including by means of general solicitation,
provided that the securities are sold only to persons that
the seller and any person acting on behalf of the seller reasonably believe is a QIB. The amendments to Rule 144A are
addressed in a separate Jones Day Commentary, available
at http://www.jonesday.com/general-solicitation-now-permitted-in-rule-144a-offerings-are-foreign-private-issuers-freeto-talk-10-07-2013/.
3 Under the Old Rule, the prohibition on general solicitation
applied to all Rule 506 offerings. As revised, that limitation is
applied only to offerings under Rule 506(b).
4 Adopting Release, at 27.
5 Adopting Release, at 28.
6 Adopting Release, at 34.
7 S e e S EC N e w C & D I s R e R u l e 14 4 A a n d R u l e 5 0 6 (c),
November 13, 2013, question 260.09.
8 Adopting Release, at 26.
+65.6233.5959
dbarsky@jonesday.com
1
Edward B. Winslow
Chicago
Michael R. Butowsky
+1.312.269.4223
New York
ebwinslow@jonesday.com
+1.212.326.8375
mrbutowsky@jonesday.com
9 In general, Section 3(c)(1) excludes from the definition of an
“investment company” any issuer whose interests are beneficially owned by not more than 100 persons. Section 3(c)(7),
which excludes from the definition of an “investment company” any issuer whose outstanding securities are owned
exclusively by “qualified purchasers” (e.g., individuals who
own at least $5 million in investments, or certain entities that
have at least $25 million in investments). In the case of nonU.S. funds, Section 3(c)(1) operates so that the fund is permitted to have an unlimited number of non-U.S. resident holders
and to conduct a U.S. offering that results in the fund having
no more than 100 beneficial owners resident in the United
States. Similarly, in the context of Section 3(c)(7), for non-U.S.
funds, issuers are permitted to offer and sell their securities
in the United States to an unlimited number of qualified purchasers, and the non-U.S. resident investors in the fund do
not have to be qualified purchasers. See No-Action Letters,
Touche Remnant & Co. (8/27/84) and Investment Funds
Institute of Canada (3/4/96).
10 Adopting Release, at 48.
Boris Dolgonos
New York
+1.212.326.3430
bdolgonos@jonesday.com
Joy Choynowska, an associate in the Singapore Office,
assisted in the preparation of this Commentary.
Jones Day publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general
information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the
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