Ask a private equity journalist about the most frustrating part of his or her job, and you likely will be told: ‘Regulations prohibiting discussion about fundraising’. Indeed, executives and compliance officers at many GPs are frightened that having an article mention their fund could be interpreted as solicitation and, as such, the US Securities and Exchange Commission (SEC) might shut down their fundraising efforts. That fear, however, could be about to recede dramatically thanks to a new law that, in theory, should help all private equity real estate firms looking to market funds.
With a stroke of his pen last month, President Barack Obama signed into law the Jumpstart Our Business Start-ups (JOBS) Act, which is designed to stimulate US jobs and economic growth by loosening restrictions on small businesses and start-up companies. Buried within the legislation is a provision allowing for private equity and hedge fund vehicles to be marketed more openly at a time when the industry, facing one of the most challenging capital-raising environments in decades, has been in need of a major boost.
The JOBS Act seeks to aid private fundraising by lifting the prohibition against general solicitation and advertising in private placements under Rule 506 of Regulation D of the Securities Act of 1933, as long as issuers sell only to accredited investors. Accredited investors, by the way, include individuals with a net worth in excess of $1 million and organisations with total assets of more than $5 million.
“What that means is that, as long as an issuer – private equity or other – is willing to accept potential disclosure liability, they can broadly offer their securities for sale,” says Matthew Kaplan, a securities partner at Debevoise & Plimpton. In theory, firms would be able to communicate via everything from email blasts to Twitter campaigns to newspaper ads.
Already, real estate practitioners are hailing the JOBS Act as being of most help to the smaller and perhaps first-time funds, rather than the more established GPs with developed fundraising capability. Still, the legislation applies to all firms and could lead to a lot more cold-calling and general advertising, both in print and via the Internet.
A boon to start-ups
Sandy Presant, chair of the real estate fund practice at Greenberg Traurig in Los Angeles, goes as far as to say that removing a constraint that has been in effect since 1982 represents “a drastic sea change” for private equity real estate. Singling out start-up firms, he notes that the ability to advertise securities – be it through email, a website, mass mailings or at the podium at an industry conference – will be “a tremendous benefit” to sponsors of funds and joint ventures. “It’ll have a widespread positive impact on the industry in terms of the ability of start-up sponsors to raise capital and the resulting availability of additional capital for acquisitions,” he adds.
On the flip side, Presant argues that established funds might avoid certain types of advertising for fear of implying that they’re unable to raise capital from their existing investor base. Such firms “want to avoid the stigma of not being selective as to who their investors are,” he says.
However, PERE spoke to one investment manager that believes the removal of the impediment would benefit not only small funds, but larger funds as well. This manager, which is planning to launch its first real estate fund but preferred not to be named, argues that both would benefit in the face of a very challenging fundraising environment.
“Everyone’s had their hands tied by these regulations,” the manager says. “Many fund managers that are complaining about the difficulty they’re having raising money or the length of time it takes to raise money obviously will find this to be helpful. Even with more established firms, I don’t think it’s going to hurt by giving them another avenue through which to raise capital.”
Waiting on the SEC
There are questions yet to be answered, however, before private equity real estate firms need never worry again about offending the authorities by talking openly about their fundraising activities.
The JOBS Act has directed the SEC to revise the rules in Regulation D to remove the general solicitation and advertising ban within 90 days of enactment of the statute. Still, some suggest the SEC might tighten certain aspects of the rules to help deter potentially fraudulent fund sponsors. The agency could be concerned that lifting the prohibition on general solicitation and advertising would open the way for unscrupulous fund sponsors, which previously were barred from mass advertising, to have greater access to investor capital. The possible revision of these rules given the elevated risk of fraud is one reason why many GPs remain unsure of how openly they can market their funds in the future.
Another unknown is whether the SEC will require additional steps for sponsors to verify that all of the LPs in a fund are accredited investors. Currently, the only verification requirement is that an investor must sign a subscription booklet that contains a representation of its accredited investor status.
In addition, the JOBS Act did not address Regulation S of the Securities Act, which exempts funds sold outside of the US from SEC registration provided that the issuer doesn’t engage in “directed selling efforts” – essentially the equivalent of general solicitation and advertising – in the US. This could pose a problem for fund sponsors that are based outside of the US and marketing private investment vehicles both in the US and abroad. The sponsor now would be able to openly market the fund in the US under the changes to Regulation D, but that would conflict directly with Regulation S and the exemption for marketing outside the US unless the SEC takes steps to harmonise the two regulations.
In a statement to PERE, the SEC acknowledged that the rule changes “have left some open questions for practitioners on implications for Regulation S offerings, which SEC staff expects to clarify.” The federal agency also is working on rulemaking to provide more information for issuers on verification requirements.
So, it remains to be seen how the SEC will implement the JOBS Act, says Greenberg Traurig’s Presant. That said, he already is advising clients “to start to consider what types of advertising, if any, they’re going to use, how they will amend their websites and how they will announce initial closings of their funds.”
Presant notes that the new statute also will require amendments to the placement agreements of many funds and joint ventures in order to allow general advertising. That is because such agreements previously prohibited placement agents from engaging in general solicitation or advertising on behalf of their clients.
A cautious approach
Others, however, anticipate that the JOBS Act will have a less significant impact in practice than it does in theory. The statute “won’t have a dramatic difference in the way people actually behave, even though they’re permitted to do something completely new,” says Jeff Berman, a partner at Clifford Chance in New York. “It’s simply because of risk aversion.”
The main advantage of the new legislation is that it will eliminate the constant worry that fund managers have when they’re marketing an offering. “There appear to be no limits” as to what fund managers can say to the press or in other public communications, Berman says, noting that GPs can speak openly about the fact they’re fundraising, the fund’s size and returns they’re targeting, the investor base they’re seeking and fund terms.
GPs, however, may be more reticent to discuss their performance track record because of the greater sensitivity and complexity involved with revealing such information, particularly if the firm is a large organisation with multiple product lines and investment teams. “I can see people putting out press releases about having achieved a first closing, for example, much more frequently than before,” provided those releases are vetted and include complete disclosure statements, Berman says. “I’m not really seeing people charging into interviews though.”
Indeed, despite the major implications of the new legislation, fund managers still appear to have many reasons to remain cautious about marketing more openly. For one thing, many are just starting to learn about the statute and, in some cases, have misconceptions about its implications.
One large GP, for example, is concerned that, by increasing public communication, it will be difficult to limit fund marketing only to accredited investors and that sponsors may be penalised by the SEC for marketing, albeit inadvertently, to non-accredited investors. “You don’t want to lose any sleep at night when you’ve just registered and you may be asked to prove that you marketed in accordance with the rules of the SEC,” the GP says. The JOBS Act, however, allows sponsors to market to anyone, as long as they actually sell only to accredited investors.
GPs also still need to be mindful of the anti-fraud requirements of the US federal securities laws, which remain unchanged by the JOBS Act and require sponsors to provide complete and accurate information about their offerings. “Anything that goes out to the public and will find its way into prospective investors’ hands – no one wants that to be misleading in any way,” says Berman. “There is a reputational risk and a legal liability if someone makes a decision on the basis of information that is not factually complete.”
Berman points out how private placement memoranda go through multiple levels of verification and review to ensure that a balanced picture of performance and strategic focus, among other information, is being provided. But with the more open communication that would be permitted under the JOBS Act, GPs could find themselves with less control over how that information is disseminated to the press or public. There is “the risk of saying something wrong if you open it up and let too many people in your shop participate in talking to people in an unaudited way,” he says.
Placement agents also are similarly wary about changing their current approach to fund marketing, given the lack of clarity over how the SEC will implement the JOBS Act. “It is still a little bit nebulous,” in terms of what can or can’t be said publicly, says Mitchell Sikora, partner at MVision Private Equity Advisers in New York. Indeed, the firm has been advised by its counsel to maintain a conservative approach to marketing until the new SEC rules are finalised.
Even after the rules are effective, however, Sikora doesn’t expect that being able to more publicly promote fundraising efforts will have a significant impact on the way his firm does business, since they already are reaching out to a wide investor base. “If it’s any benefit, it’s really on the margins,” in terms of connecting MVision to the odd investor or two that they otherwise may have missed. “It’s not like I’m jumping up and down, and I think this is going to change my life.”
Maybe not, but the JOBS Act could yet have a huge impact on the way funds are marketed in the future – and on the way firms interact with the press when in fundraising mode.