SEC answers questions on general solicitation

The US Securities and Exchange Commission (SEC) answered a few questions on general solicitation as GPs wait to test the waters on their newfound freedom to market funds over the public airwaves.

The SEC voted to lift the ban on general solicitation last year as part of Dodd-Frank reform, but guidance is still pending and confusion surrounding how to ensure that investors are accredited has dampened its popularity.

Four paths are available for GPs to prove that “reasonable steps” have been taken to ensure accreditation as the rule requires. Those provisions exist to prevent mom-and-pop investors from entering private funds – which the SEC sees as too risky and sophisticated for inexperienced investors to take part in.

One method is to review an investor’s Internal Revenue Service (IRS) tax forms in “the two most recent years” prior to the commitment. When a prospective investor doesn’t have a completed tax form for the most recently completed year (meaning 2013), the SEC said GPs can rely on their 2012 and 2011 tax forms so long as the LP provides written representation that the 2013 tax form isn’t yet available and that when it is, it will show they still generate enough income to be an accredited investor.

Even with written certification GPs would still need to investigate any signs that the investor may not be accredited, including for example if the LP’s 2012 tax form barely met the thresholds required, the SEC said in an updated FAQ on Securities Act rules posted to its website.

GPs can also rely on an investor’s most recently available tax forms to determine that that their net worth confirms their accredited investor status while reviewing documentation of the LP’s assets and liabilities. The SEC said this was part of its “principles-based” method and is meant to provide some flexibility in the process.

The SEC also said GPs can rely on foreign tax forms from non-US investors (that can’t provide IRS forms to report their income) so long as the foreign tax authority imposes penalties for falsely-reported information much in the same way that the US does. Likewise, GPs can use nationwide consumer reporting agencies from outside the US, within reason, to conclude a LP is an accredited investor.

The additional guidance comes at a time of great confusion about the SEC’s expectations of fund advisers who decide to be among the first to publicly market their funds. In a recent comment letter, pfm argued general solicitation will not gain significant traction in the industry until the commission offers more clarity around the penalties for non-compliance and other lingering questions.