Federal regulators will allow private fund customers to certify that they meet the definition of accredited investors under new guidance that backers hope may wake a sleepy corner of the otherwise booming private funds market.
In a new no-action letter addressed to lawyers at Latham & Watkins, Jeb Byrne, the chief of small business policy at the SEC’s division of corporation finance, said commission staffers “agree that a high minimum investment amount is a relevant factor in verifying accredited investor status” and that, so long as a fund manager has “no actual knowledge” that a putative accredited investor doesn’t meet the standard’s wealth thresholds and that the investment isn’t “being financed in whole or in part by any third-party,” then a fund manager “could reasonably conclude that it has taken reasonable steps to verify that purchasers of securities sold in an offering under rule 506(c) of Regulation D are accredited investors.”
Under rule 506(c) of the JOBS Act, fund managers are allowed to make “general solicitations” – that is, sell their wares to the general public – so long as they only sell to accredited investors. Since the rule’s adoption in 2013, only a handful of funds have relied on 506(c)’s safe harbor, in part because it hasn’t been clear what the rule meant when it required fund managers to take “reasonable” steps to ensure their investors are accredited. Between 2022 and 2023, only 6 percent of fund raises came under 506(c), SEC statistics show.
Byrne’s March 12 letter to Latham & Watkins allows fund managers to rely on a given investor’s self-representation that they meet the accreditation standards. It’s a coup for Latham’s attorneys and could be a boon for the entire private funds industry.
‘A very big deal’
“We think this is a very big deal,” Latham & Watkins partner Nadia Sager told affiliate publication Private Funds CFO. “The whole idea behind 506(c) was that you could open the private market up broadly. It hasn’t worked out that way. This will have a lot more utility now that there’s more certainty.”
The JOBS Act already super-charged the private funds industry through 506(b) offerings that don’t involve general solicitations. By 2019, for every dollar raised by a public company, three more went into private funds, SEC statistics show.
But funds relying on 506(c) are a fraction of the market. Between 2022 and 2023, SEC statistics show 506(c) offerings raised $169 billion, in contrast to the $2.7 trillion collected through 506(b) offerings.
That’s in part because while other parts of the market were allowed to let their investors self-certify their accreditation, it wasn’t clear that self-certification was kosher under 506(c), Latham partner Joel Trotter said. The background checks most funds used to certify investors for 506(c) offerings were “invasive” and kept many large institutions out of the game, Trotter said.
“Once the most sophisticated investors vote with their feet – once they say, ‘Thanks but no thanks,’ the perception becomes self-reinforcing and that limits market acceptance,” he noted.
The self-certified era
The new SEC guidance document, Trotter said, “begins a new era for this type of fundraising.”
Under the no-action guidance letter, funds will be allowed to assume that investors who can write a check to cover the minimum standards for accreditation – $200,000 for a single person and $1 million for a company, nonprofit group or other organization – meet the statute’s wealth thresholds. The minimum investment standards, advocates say, will help keep retail investors out of higher-risk private funds.
“This doesn’t lower standards for who can invest,” said Latham & Watkins partner Sager. “All it does is help verify that an investor meets the standards.”
It will also help companies and funds preserve private placement fundraising rights even if they “inadvertently” let slip word of their fundraising, Sager added. Without the new guidance letter, if word slipped out about a fundraise, the company or fund would have problems using 506(b)’s protections, she said.
“We think it could take over the market,” she noted.
Trotter said he and his partners had been looking for ways to clarify self-certification for more than a decade, ever since the SEC adopted its JOBS Act rules in 2013. “What the market lacked was certainty on how to use minimum investment amounts as a verification step,” he said.
With a new administration in town, Trotter said he and his partners saw an opportunity. Last November, shortly after the presidential election, Republican SEC commissioner Hester Peirce spoke to the commission’s small business advisory council.
She cited recent research that argued, among other things, that the 506(c) certification process was a drag on the market. She urged the council to rethink things and asked, “What else can the SEC do to create a regulatory environment in which talented emerging fund managers, including those who do not have wealthy networks, can get a competitive toehold?”
The Latham attorneys took that as further encouragement.
“It’s been on our wish list for a long time,” Trotter said. “The actual discussions with staff, though, that all happened very quickly, and it shows that today’s SEC wants to promote capital formation while protecting investors.”
Federal regulators will allow private fund customers to certify that they meet the definition of accredited investors under new guidance that backers hope may wake a sleepy corner of the otherwise booming private funds market.
In a new no-action letter addressed to lawyers at Latham & Watkins, Jeb Byrne, the chief of small business policy at the SEC’s division of corporation finance, said commission staffers “agree that a high minimum investment amount is a relevant factor in verifying accredited investor status” and that, so long as a fund manager has “no actual knowledge” that a putative accredited investor doesn’t meet the standard’s wealth thresholds and that the investment isn’t “being financed in whole or in part by any third-party,” then a fund manager “could reasonably conclude that it has taken reasonable steps to verify that purchasers of securities sold in an offering under rule 506(c) of Regulation D are accredited investors.”
Under rule 506(c) of the JOBS Act, fund managers are allowed to make “general solicitations” – that is, sell their wares to the general public – so long as they only sell to accredited investors. Since the rule’s adoption in 2013, only a handful of funds have relied on 506(c)’s safe harbor, in part because it hasn’t been clear what the rule meant when it required fund managers to take “reasonable” steps to ensure their investors are accredited. Between 2022 and 2023, only 6 percent of fund raises came under 506(c), SEC statistics show.
Byrne’s March 12 letter to Latham & Watkins allows fund managers to rely on a given investor’s self-representation that they meet the accreditation standards. It’s a coup for Latham’s attorneys and could be a boon for the entire private funds industry.
‘A very big deal’
“We think this is a very big deal,” Latham & Watkins partner Nadia Sager told affiliate publication Private Funds CFO. “The whole idea behind 506(c) was that you could open the private market up broadly. It hasn’t worked out that way. This will have a lot more utility now that there’s more certainty.”
The JOBS Act already super-charged the private funds industry through 506(b) offerings that don’t involve general solicitations. By 2019, for every dollar raised by a public company, three more went into private funds, SEC statistics show.
But funds relying on 506(c) are a fraction of the market. Between 2022 and 2023, SEC statistics show 506(c) offerings raised $169 billion, in contrast to the $2.7 trillion collected through 506(b) offerings.
That’s in part because while other parts of the market were allowed to let their investors self-certify their accreditation, it wasn’t clear that self-certification was kosher under 506(c), Latham partner Joel Trotter said. The background checks most funds used to certify investors for 506(c) offerings were “invasive” and kept many large institutions out of the game, Trotter said.
“Once the most sophisticated investors vote with their feet – once they say, ‘Thanks but no thanks,’ the perception becomes self-reinforcing and that limits market acceptance,” he noted.
The self-certified era
The new SEC guidance document, Trotter said, “begins a new era for this type of fundraising.”
Under the no-action guidance letter, funds will be allowed to assume that investors who can write a check to cover the minimum standards for accreditation – $200,000 for a single person and $1 million for a company, nonprofit group or other organization – meet the statute’s wealth thresholds. The minimum investment standards, advocates say, will help keep retail investors out of higher-risk private funds.
“This doesn’t lower standards for who can invest,” said Latham & Watkins partner Sager. “All it does is help verify that an investor meets the standards.”
It will also help companies and funds preserve private placement fundraising rights even if they “inadvertently” let slip word of their fundraising, Sager added. Without the new guidance letter, if word slipped out about a fundraise, the company or fund would have problems using 506(b)’s protections, she said.
“We think it could take over the market,” she noted.
Trotter said he and his partners had been looking for ways to clarify self-certification for more than a decade, ever since the SEC adopted its JOBS Act rules in 2013. “What the market lacked was certainty on how to use minimum investment amounts as a verification step,” he said.
With a new administration in town, Trotter said he and his partners saw an opportunity. Last November, shortly after the presidential election, Republican SEC commissioner Hester Peirce spoke to the commission’s small business advisory council.
She cited recent research that argued, among other things, that the 506(c) certification process was a drag on the market. She urged the council to rethink things and asked, “What else can the SEC do to create a regulatory environment in which talented emerging fund managers, including those who do not have wealthy networks, can get a competitive toehold?”
The Latham attorneys took that as further encouragement.
“It’s been on our wish list for a long time,” Trotter said. “The actual discussions with staff, though, that all happened very quickly, and it shows that today’s SEC wants to promote capital formation while protecting investors.”
