When the SEC finalizes proposed rules that eliminate the prohibition on general solicitation and general advertising, private funds will be free to jump in and publicly offer their securities, right?
Not so fast, especially if the private fund is a commodity pool under the Commodity Exchange Act.
Among other things, Section 201(a)(1) of the JOBS Act mandated the SEC to revise Rule 506 of Regulation D under the Securities Act to eliminate the prohibition against general solicitation and general advertising for offerings to accredited investors. Section 201(b) of the JOBS Act amends Section 4 of the Securities Act of 1933 to clarify that offerings made under Rule 506 won't be considered public offerings under the federal securities laws if they rely on the exemption.
Private funds, including hedge funds that are also commodity pools, typically rely on Section 4(a)(2) and Rule 506 to offer their interests without registration under the 1933 Act. Private funds also generally rely on exclusions from the definition of an investment company provided by either Section 3(c)(1) or 3(c)(7) of the Investment Company Act. But, as a condition to rely on either of these exclusions, the issuer must be one that is not making and does not propose to "make a public offering" of its securities.
The SEC's long-awaited rule proposals implementing Section 201(a) recognize the issue. The SEC unambiguously stated that it believes that Congress, in adopting Section 201(b) of the JOBS Act, intended to let privately offered funds make a general solicitation under amended Rule 506 "without losing either of the exclusions under the Investment Company Act."
While the JOBS Act addresses private offerings for purposes of the federal securities laws, it does not specifically address how the Section 201(a) would apply to regulation of commodity pools that are exempt from registration under the CEA.
In particular, consider CFTC rule 4.7 and rule 4.13(a)(3), which exempt certain hedge funds and other commodity pools from the CEA's registration requirements. A fund can rely on rule 4.7(b) only if it "offers or sells participations in a pool solely to qualified eligible persons." It is not clear whether this condition prohibits marketing to the public, as contemplated in the proposed amendments to Rule 506. Similarly, a fund can rely on the de minimis exception, rule 4.13(a)(3), only if the pool interests are exempt from registration under the 1933 Act "and may not be marketed in public in the United States."
The result is that the CFTC's rules are not in harmony with the federal securities regulations. That is, private funds that invest only in securities and security-based swaps, may engage in general solicitation and advertising, while private commodity pools, including those that rely on the rule 4.13(a)(3) de minimis exception, would not be able to engage in general solicitation and advertising.
The Managed Funds Association makes a cogent argument in its July 17, 2012 comment letter to the CFTC concerning harmonization of compliance obligations under JOBS Act and CFTC regulations.
We hope the CFTC gives serious consideration to the MFA's comment.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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