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SEC’s JOBS Act liberalization effective September 23, 2013

Wednesday, August 28, 2013

David E. McClean
Opalesque Industry Update - New and long-awaited SEC rules under the JOBS Act have been published in the US Federal Register. The Rules will be effective on September 23 (Source).

This means that private funds that are not also registered as commodity pools will be able to begin general solicitations for investment on that date.

Exploiting these liberalizations means, for example, no longer qualifying investors as “accredited investors” prior to contact/offering/solicitation, and contact/offering/solicitation may be made in various ways. For example, via direct mailings (including e-mails) of a general distribution, or via instant access to fund offering memoranda and fund information at the home page of a firm’s web site, or via advertisements in generally circulated publications.

Bear in mind that direct contact with potential investors in the United States (such as via bulk e-mail) must still be made by duly licensed registered representatives, all else being equal, were sales compensation will be paid, generally speaking. In such case, any solicitation should indicate that offers are being made via a registered broker-dealer, with an appropriately licensed broker-dealer contact indicated for follow-up.

However, the JOBS Act does not change the requirement that investors must be “accredited investors” when actually investing in a fund. In fact, the requirement to determine “accredited investor” status, especially for natural person investors, has been made a bit more stringent. The mere representations of “accredited investor” status will no longer be enough.

Here are the requirements for determining the status of natural person investors prior to investment:

1. The fund shall be deemed to have taken reasonable steps to verify an investor’s status as an accredited investor if the fund uses, at its option, one of the following non-exclusive and non-mandatory methods of verifying that a natural person who purchases securities in such offering is an accredited investor:

A. In regard to whether the investor is an accredited investor on the basis of income, reviewing any Internal Revenue Service form that reports the purchaser’s income for the two most recent years (including, but not limited to, Form W-2, Form 1099, Schedule K-1 to Form 1065, and Form 1040) and obtaining a written representation from the purchaser that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year;

B. In regard to whether the purchaser is an accredited investor on the basis of net worth, reviewing one or more of the following types of documentation dated within the prior three months and obtaining a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed:

(1) With respect to assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments, and appraisal reports issued by independent third parties; and
(2) With respect to liabilities: a consumer report from at least one of the nationwide consumer reporting agencies; or

Obtaining a written confirmation from one of the following persons or entities that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that such purchaser is an accredited investor:

(1) A registered broker-dealer;
(2) An investment adviser registered with the Securities and Exchange Commission;
(3) A licensed attorney who is in good standing under the laws of the jurisdictions in which he or she is admitted to practice law; or
(4) A certified public accountant who is duly registered and in good standing under the laws of the place of his or her residence or principal office.

If a natural person accredited investor is already an investor in a fund, we the fund must obtain a re-certification from the investor, if solicited in a general solicitation to invest in the fund, stating that the investor qualifies as an accredited investor.

Note that, according to the new rules:

1. A fund is not required to use any of these methods in verifying the accredited investor status of natural persons who are purchasers. These methods are examples of the types of non-exclusive and non-mandatory methods that satisfy the verification requirement;

2. In the case of a person who qualifies as an accredited investor based on joint income with that person’s spouse, the issuer would be deemed to satisfy the verification requirement by reviewing copies of Internal Revenue Service forms that report income for the two most recent years in regard to, and obtaining written representations from, both the person and the spouse;

3. In the case of a person who qualifies as an accredited investor based on joint net worth with that person’s spouse, the issuer would be deemed to satisfy the verification requirement by reviewing such documentation in regard to, and obtaining written representations from, both the person and the spouse.

The upshot of all of this is that sales persons must dig deeper into the accredited investor status of natural person investors, using one or more (or similar or equivalent) methods of verification.

Alert from Dr. David E. McClean, Principal, DMA Consulting Group, Inc.

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