The Securities and Exchange Commission is currently accepting comments on a proposed rule change that would, among other things, update the definition of “accredited investor” to include having $2.5 million in investment assets. This would raise the bar for who can invest in a private investment pool.
Not many in the private equity industry will be hurt by this impending change to the definition of “accredited”, which currently requires a $1 million net worth. But while the SEC is rethinking this rule, they should (and, indeed, already do) seriously consider dropping a flawed ban on generally publicising and advertising fundraisings to the private equity market. Anyone who has written about private equity for a trade or mainstream publication has encountered a recurring motif peculiar to this industry. It can best be described as a nudge-nudge, wink-wink routine surrounding the raising of private equity funds.
The exact approach that a GP or placement agent takes in dealing with the media during a fundraising is typically dictated by the legal counsel to the offering. Some lawyers (bless them) impose a draconian code of silence under which a GP with a fund in the market is barred from so much as telling someone who looks like a reporter what time it is. On the other end of the spectrum are those lawyers (bless them even more) who tell clients to go ahead and confirm details of a fundraising to the media, so long as the information is delivered “on background” and is not attributable to the GP in question.
I recently attended a press dinner sponsored by a large buyout group, at which the firm's founder rose to speak, but prefaced his comments by saying that because he had a fund in the market, we were all to regard the dinner, his comments and the entire evening as having never existed.
Making this prohibition-like environment possible is Rule 502(c) of Regulation D of the Securities Act of 1933, which states that non-registered securities (like private equity funds) may not be offered “by any form of general solicitation or general advertising”. This is because general solicitations have the potential to reach unaccredited investors. But really, so what?
Everyone agrees that private equity funds are for sophisticated investors who should be able to evaluate the risks associated with committing to such funds, have the wherewithal to sniff out noxious managers, and be rich enough to still feed the kids should the investments go awry. No, nobody wants Widow McFeely to get suckered into some disreputable buyout fund. But Rule 502(c) dictates a flawed approach to protecting unsophisticated investors, an approach that implies that they potentially suffer by being exposed to the marketing materials for unregistered securities. In fact, they potentially suffer when allowed to invest in unregistered securities.
The SEC currently protects unaccredited investors from flipping through the Wall Street Journal and coming across an announcement that Maximus Capital Partners IV is seeking $400 million for private equity investments. But no harm is done by anyone merely viewing the ad. And no harm is done if Widow McFeely lusts after the opportunity to invest and calls the fund's placement agent about becoming an investor. The crime occurs if Maximus takes the widow's money.
In fact, an SEC advisory committee in April noted that “no offeree has ever lost any money unless he or she became a purchaser”. Based on this committee's investigations, the SEC is considering liberalising “manner of offering” restrictions, in part because the current rules “focus a disproportionate amount of time and effort on persons who may never purchase [restricted] securities…”
Momentum is building for a change to solicitation rules. If a change occurs, the ways that LPs and GPs connect could become far more efficient and aided by the serendipity that occurs in a free media environment. As Jedd Wider, a partner in the New York office of law firm Morgan Lewis & Bokius, wrote for sister publication Private Equity Manager last September, “the proposed modifications […] will enable private fund sponsors and agents to reach a broader retail market and provide for greater opportunities for capital raising…”
And GPs in the market with a fund will finally be able to speak easy when a reporter calls.
If a change occurs, the ways that LPs and GPs connect could become far more efficient and aided by the serendipity that occurs in a free media environment.