A "Comment Letter" Worth Noting on the SEC's Proposed General Solicitation Rules

 By Cydney Posner

According to an article in Business Insider, at least one Senator appears to be mounting a serious challenge to the SEC's interpretation of Section 201 (elimination of the prohibition on general solicitation) of the JOBS Act.

As you may recall, under the SEC's proposed rules to eliminate the prohibition on general solicitation, companies would be permitted to use general solicitation and general advertising to offer securities under Rule 506 of Reg D and Rule 144A. While the proposed rules would require Issuers  to take "reasonable steps" to verify that investors are accredited, the proposal is not prescriptive as to what those steps must be.  (See News Brief dated 8/29/12.) The SEC's proposing release notes that providing for specific verification methods that an issuer must use "would be impractical and potentially ineffective in light of the numerous ways in which a purchaser can qualify as an accredited investor … We are also concerned that a prescriptive rule that specifies required verification methods could be overly burdensome in some cases, by requiring issuers to follow the same steps, regardless of their particular circumstances, and ineffective in others, by requiring steps that, in the particular circumstances, would not actually verify accredited investor status."

As the article notes, however, by "effectively punting its primary directive, the SEC appears to have opened the door to Congress reframing the scope of the mandate entirely….. In response [to the proposal], Senator Carl Levin (D-MI) sent a terse letter to the SEC, reprimanding the SEC for drafting a proposed rule that ‘provides no certainty to issuers and fails to establish methods sufficient to ensure that only accredited investors participate in the offerings.' He further notes that it was made clear that ‘self-certification' of accredited investors is inadequate, suggesting that the SEC's proposed rules need to require common-sense documentation and/or verification practices and procedures."

Most surprising perhaps is Senator Levin's introduction of a novel distinction in the application of Rule 506.  In his letter, he asserts that the provision in the JOBS Act prohibiting general solicitation was intended to apply to operating businesses only and not to private investment vehicles at all: "Congress did not contemplate removing the general solicitation ban – without retaining any limitations on forms of solicitation – for private investment vehicles. Indeed, no argument was made during the debate of the bill that the objective was to ease the capital aggregation process for private investment vehicles. The words ‘hedge fund,' ‘private fund,' or ‘investment vehicle' were not used either during the committee or floor debate in the House of Representatives. Nor did the Senate engage in any debate relating to removing these advertising and marketing restrictions completely from private investment vehicles." 

It remains to be seen whether other legislators on the right side of the political spectrum now jump into the fray to defend  the application of the provision to hedge funds and other private investment vehicles.  Presumably, representatives of the fund community will also use the comment process to counter Senator Levin's view.  In any event, it will be interesting to see how the SEC responds to this latest assault on its rule-making efforts.

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