SEC Staff: Reg D Issuers Can Safely Provide Factual Business Information
New FAQs from the SEC’s Division of Corporate Finance provide some helpful clarification for private fund advisers seeking to disseminate information. But some caution is warranted: The interpretations also raise new questions.
The FAQs, published August 6, "provide practical guidance on questions affecting investment advisers, broker-dealers and others – such as what kind of information can be shared widely without constituting general solicitation, what constitutes a ‘pre-existing’ or a ‘substantive’ relationship and who can have such a relationship for purposes of Rule 502(c), and what kind of parameters should exist around participation in ‘demo days’ or ‘venture fairs’ in keeping with the rule’s prohibition on general solicitation," said Willkie Farr partner James Burns.
The big takeaway for advisers is that private funds relying on Regulation D may disseminate information that does not involve an offer of securities without violating Rule 502(c), which prohibits such solicitation in Regulation D offerings. Factual business information that "does not condition the public mind or arouse public interest in a securities offering is not an offer and may be disseminated widely," the staff said.
Moreover, the staff came close to providing a definition of what would constitute factual business information. "Factual business information typically is limited to information about the issuer, its business, financial condition, products, services, or advertisement of such products or services, provided the information is not presented in such a manner as to constitute an offer of the issuer’s securities," adding that the facts and circumstances of each situation will also apply. "Predictions, projections, forecasts or opinions" with respect to the valuation of a security or a continuously offered fund would most likely not be acceptable, it said.
But in the new interpretation lies the rub. How does one determine when information "does not condition the public mind"? While the list of specific types of information that can be safely listed will "provide private fund advisers with a little more comfort" as to the information they provide, other information – such as an announcement of future funds – might be seen as "priming the pump" for that upcoming offering, said Mayer Brown attorney Adam Kanter.
"Market participants will find the guidance helpful, but many of the issues addressed will still require that firms evaluate the particular facts and circumstances presented before taking comfort they are not engaging in solicitation," Burns said.
The best course for advisers would be to hew to a conservative course, Kanter said, feeling comfortable when listing basic business information such as the types listed in the FAQ, but avoiding any other information that "might be seen as intending to generate additional interest." Advisers should also review their firms’ policies and procedures for determining an investor’s eligibility to invest in a private fund.
Nature of the relationship
The FAQs also offered clarification on when an offer of securities under Regulation D to a prospective investor could be considered to be part of a pre-existing, substantive relationship. Such relationships are one way of "demonstrating the absence of a general solicitation," which is prohibited under Regulation D, the staff said.
A "pre-existing" relationship, according to one FAQ, is "one that the issuer has formed with an offeree prior to the commencement of the securities offering or, alternatively, that was established through either a registered broker-dealer or investment adviser prior to the registered broker-dealer or investment adviser participation in the offering."
The staff, in the same FAQ, also made clear that "there is no minimum waiting period" to establish such a relationship. This clarifies previous regulatory guidance found in the 1997 Lamp Technologies letter, which required that an individual who qualifies as an accredited investor wait 30 days before making an investment in a private fund in order to evidence a pre-existing relationship and to provide a cooling-off period. The new interpretation makes clear that the relationship must be established prior to the time the registered broker-dealer or investment adviser begins participating in the offering, and that a waiting period is required only for accredited investors who invest in a private fund that was posted on a website platform prior to the investor’s subscription to the platform.
"So long as a substantive relationship has been established prior to the commencement of any offering, a 30-day waiting period in most cases serves no purpose," said Day Pitney counsel Eliza Sporn Fromberg. "The key is that to avoid a general solicitation, the relationship must exist before the adviser begins participating in the offering."
What makes a relationship "substantive" enough so that an offering of securities would not violate Rule 502(c)’s general solicitation ban would be the issuer or its adviser having "sufficient information to evaluate … a prospective offeree’s financial circumstances and sophistication in determining his or her status as an accredited or sophisticated investor," the SEC staff said. But it added that self-certification alone, as in simply checking a box, without any other knowledge of a person’s financial circumstances or sophistication would not be sufficient.
The SEC staff "makes clear that there is a real standard in defining what constitutes a substantive relationship," said Fromberg. "Advisers and broker-dealers have to make sure they do their legwork in order to determine that a particular investor’s financial circumstances and sophistication level qualify that person to invest in a private offering."
Other solicitation situations
Also good news is that having a pre-existing, substantial relationship with potential investors is not the only situation in which funds may solicit purchases of their offerings. "The staff is aware of long-standing practices were issuers and persons acting on their behalf are introduced to prospective investors who are members of an informal, personal network of individuals with experience investing in private offerings," one of the FAQs said, providing "angel investors" as an example of such a group.
"Issuers that contact one or more experienced, sophisticated members of the group through this type of referral may be able to rely on those members’ network to establish a reasonable belief that other offerees in the network have the necessary financial experience and sophistication." Whether there has been a general solicitation in such a group will depend on the facts, the staff said, noting that the greater the number of persons with financial experience and sophistication in the group, the better.
The staff also noted that a demo day or venture fair may not be considered general solicitation if the attendees are invited to the event based on the existence of a pre-existing, substantive relationship or were invited through a network of sophisticated investors.