With President Barack Obama signing the Jumpstart Our Business Start-ups (JOBS) Act into law, a number of aspects on how the federal government regulates the private equity real estate industry will change considerably. In particular, the JOBS Act will ease restrictions on advertising and solicitation of investors for private investment vehicles.
For those of us who have been following the industry, this is potentially huge and good news. For the past 20 years, Regulation D has prevented firms from publicly distributing information about their funds, which contributed to the industry’s reputation for opacity. (It’s not called private equity for nothing.) The new JOBS Act opens the possibility of firms trumpeting their fundraising efforts through mainstream outlets like print advertisements or social media. At least, in theory.
We at PERE don’t expect the industry to change overnight. These strict regulations have instilled within GPs an almost bone-deep aversion to publicity and media attention for the past two decades, so it’s unlikely that fund managers will be quick to disclose details on their latest fund offerings. Old habits do die hard.
However, this new law could be the first major step towards bringing some much-needed transparency to the private equity real estate sector, and a greater level of transparency could greatly benefit the industry. It would enable fund managers to cast a wider net for seeking investors. In turn, LPs would be more aware of the vast variety of commingled vehicles in the market. In particular, the easing of disclosure restrictions could serve as a boon to newer, emerging fund managers. Lastly, the lifting of these restrictions could enable and encourage more open communication between GPs and LPs.
Not surprisingly, the industry is both split and cautious about what exactly this new JOBS Act will mean for fund managers. While some industry insiders believe that the elimination of these restrictions will help new or smaller firms raise their profile, others have strongly cautioned fund managers from showing their cards too soon. The Dodd-Frank Act required many private equity real estate firms to register as financial advisors, which in turn subjects them to solicitation and advertising guidelines that are quite stringent – though less so than those under the previous regulatory regime.
Still, many fund managers remain cautious. (A carefully fostered culture of secrecy and…we’ll say it, fear…will do that.) First off, many GPs are just learning about this statute. In addition, of those fund managers, a large portion is still unclear about its meaning and what is and is not allowed.
Furthermore, the JOBS Act did not address Regulation S of the Securities Act, which exempts funds sold outside of the US from Securities and Exchange Commission (SEC) registration, provided that the issuer doesn’t engage in “directed selling efforts,” which are the equivalent of general solicitation in the US. This could potentially be a problem for foreign fund sponsors marketing private investment vehicles both in and out of the US.
Meanwhile, some have speculated that the newly enacted legislation overhauling Regulation D will lead to increased fraud and open the doors to a potential lawlessness akin to the Wild West. For example, lifting the ban on general solicitation could enable less scrupulous fund managers that previously were barred from mass advertising to have greater access to investor capital. Although a number of industry insiders think less regulations could lead to more fraud, few think it will be rampant. Indeed, there are still several other regulations out there, such as the previously-mentioned Dodd-Frank Act, to mitigate a good deal of fraud risk.
This development also raises a potentially interesting, albeit tangential, question: what will happen to placement agents? After all, if a fund manager is free to openly publicise and solicit for its commingled vehicle, why would it need a third party to raise capital on its behalf? That could be a big problem for an industry that already is struggling with a tough fundraising environment and fierce competition.
While it is true that the JOBS Act raises a number of as-yet-unanswered questions, including the ones posed above, the biggest question is how the SEC will react. The regulator has 90 days from enactment to get Regulation D in line with the mandate of the new statute. How it goes about reconciling the two opposing directives remains to be seen, as well as whether the agency creates new hoops for GPs to jump through.
One thing we do know is that the new legislation will eliminate a good deal of the worry that fund managers have when they’re marketing an offering. Now, GPs will have the prerogative to speak openly not only about the fact they’re fundraising, but also the fund size and returns they’re targeting, the investor base they’re seeking and fund terms. Whether or not they wind up taking advantage of that prerogative remains to be seen.