JOBS Act Update: Exempt Commodity Pools May Engage in General Solicitation
On September 9, 2014, the Division of Swap Dealer and Intermediary Oversight of the Commodity Futures Trading Commission (CFTC) issued an Exemptive Letter (CFTC Letter No. 14-116) that effectively opens the door for private funds (e.g., hedge funds and private equity funds) that trade commodity interests to engage in general solicitation and advertising in raising capital from investors while remaining exempt from many of the substantive provisions of the Commodity Exchange Act (the “CEA”) pursuant to existing CFTC regulations.[i] It is important to note that relief under the Exemptive Letter is not self-executing – a notice must be filed with the CFTC in order to claim it.
JOBS Act Background
In 2012, Congress enacted the Jumpstart Our Business Startups Act (the “JOBS Act”) with the goal of promoting job creation and economic growth by making it easier for emerging growth companies to raise capital. To that end, a key provision of the JOBS Act directed the Securities and Exchange Commission (SEC) to amend its rules for private placements of securities in reliance on Rule 506 of Regulation D under the Securities Act of 1933 (the “Securities Act”) so as to permit general solicitation and advertising (hereinafter, “general solicitation”) provided that all purchasers in the offering are accredited investors and the issuer takes reasonable steps to verify that such purchasers are accredited investors.[ii] The JOBS Act also directed the SEC to amend Rule 144A under the Securities Act to provide that securities resold in reliance on that Rule could be offered to persons that are not “qualified institutional buyers” (QIBs) via general solicitation so long as the securities are actually sold only to persons the seller and any person acting on its behalf reasonably believes are QIBs.
In accordance with this directive, the SEC amended Rules 506 and 144A in July 2013. To implement the required changes to Rule 506, the SEC created a new Rule 506(c), which allows general solicitation under the conditions set forth in the JOBS Act, but retained the existing Rule 506 exemption and redesignated it as Rule 506(b). Issuers raising capital under Rule 506(b) or Section 4(a)(2) of the Securities Act outside of Rule 506, remain subject to the prohibition on general solicitation.
Marketing Restrictions Under CFTC Regulations
For many entities that are “commodity pools” within the meaning of the CEA (generally, any investment trust, syndicate or similar form of enterprise that trades commodity interests), the SEC’s lifting of the ban on general solicitation under Rule 506 and Rule 144A was of limited usefulness. That is because two exemptions under CFTC regulations that are widely used by these entities include restrictions on marketing to the public (effectively precluding general solicitation). [iii] The JOBS Act did not include a specific directive to the CFTC to remove such restrictions as it had with respect to the SEC and Rules 506 and 144A.
The first exemption, CFTC Regulation 4.7, provides limited relief from disclosure, reporting and recordkeeping requirements that are otherwise generally applicable to commodity pools and commodity pool operators (CPOs) under CFTC rules.[iv] One of the conditions of eligibility for this exemption is that offers and sales of the commodity pool interests (i.e. the offered securities) may be made only to “qualified eligible persons” (QEPs) in an offering that qualifies for exemption under Section 4(a)(2) under the Securities Act (or under Regulation S). As noted above, Section 4(a)(2) offerings, in contrast to Rule 506(c) offerings, are still subject to the prohibition on general solicitation. Moreover, general solicitation would be inconsistent with the Regulation 4.7 requirement that both offers and sales are restricted to QEPs.
The second exemption, CFTC Regulation 4.13(a)(3), provides a complete exemption from CFTC registration for CPOs that operate certain commodity pools with a de minimis amount of commodity interests. This exemption requires that the commodity pool interests be “offered and sold without marketing to the public in the United States.” Because general solicitation is tantamount to marketing to the public, a CPO engaging in general solicitation in reliance on Rule 506(c) would fail to meet this requirement.
Similarly, if resellers of the commodity pool interests were permitted to resell such securities in reliance on Rule 144A and engage in general solicitation in doing so (as now permitted pursuant to the JOBS Act), the exemptive relief of Regulation 4.7 and Regulation 4.13(a)(3) would not be available.
Exemptive Letter Harmonizes Exemptions
The Exemptive Letter harmonizes the exemptions in CFTC Regulations 4.7 and 4.13(a)(3) with the JOBS Act’s directive for the SEC to remove the marketing restrictions in Rules 506 and 144A. Specifically, the CFTC’s Exemptive Letter sets forth the conditions under which a CPO may (i) engage in general solicitation with respect to the commodity pool interests (i.e. fund shares or partnership interests) as permitted by Rule 506(c) or (ii) allow resellers of such interests that are relying on Rule 144A to engage in general solicitation, and in either such case still qualify for exemptive relief under Regulation 4.7 or 4.13(a)(3), notwithstanding the marketing restrictions in such Regulations described above.
The relief granted by the Exemptive Letter is strictly limited to CPOs who are relying on Rule 506(c) or resellers of commodity pool interests that are relying on Rule 144A. Additionally, the relief is not self-executing and therefore requires the CPO to file a notice with the CFTC to claim the relief, to be effective upon filing provided that it is materially complete and accurate. The required notice must (i) include the name, address and contact information of the CPO, (ii) state the name(s) of the pool(s) for which relief is being claimed, (iii) indicate whether the CPO claiming relief is relying on Rule 506(c) or Rule 144A, (iv) specify whether the CPO is seeking exemptive relief under Regulation 4.7 or 4.13(a)(3) and represent that the conditions to such exemption are satisfied and (v) be signed by the CPO. Notices are required to be filed with the CFTC via email as provided in the Exemptive Letter.
The relief granted by the Exemptive Letter remains effective until the CFTC takes final action in consideration of the JOBS Act. No indication is given as to if or when that may occur.
Operators of private funds that trade commodity interests and claim an exemption under CFTC Regulation 4.7 or 4.13(a)(3) who now are considering whether to engage in general solicitation in connection with Rule 506(c) offerings or Rule 144A resales, should proceed cautiously. CPOs should weigh the perceived benefits of a general solicitation offering against the potential risks – will general solicitation in fact generate appropriate investor interest and investment in the fund, or simply heighten the profile of the offering and raise compliance risks under both the Securities Act and the CEA without material benefit to the fund? If general solicitation is used in reliance on Rule 506(c) or Rule 144A, CPOs should take care to ensure that all other requirements for relying on such Rules are met. In particular, CPOs relying on Rule 506(c) will need to perform reasonable verification steps with regard to investors’ accredited investor status.[v]
For more information regarding this Corporate and Securities Alert, please contact Neil Casey (212.631.4414; email@example.com) or Lori S. Smith (212.714.3075; firstname.lastname@example.org) in our New York office.
[i] Under the CEA, “commodity interests” include swaps, security futures products, commodities for future delivery and commodity options, among other things.
[ii] For a discussion of the JOBS Act provisions related to general solicitation, please see our prior Securities Alert at http://www.whiteandwilliams.com/resources-alerts-General-Solicitation-and-Public-Private-Placements-Navigating-the-Minefield-Planted-by-New-and-Proposed-SEC-Rules.html.
[iii] For a discussion of CFTC exemptions relevant to private funds, please see our prior Securities Alert at http://www.whiteandwilliams.com/resources-alerts-CFTC-Repeals-CPO-Exemption-Commonly-Used-by-Private-Investment-Funds.html
[iv] A “commodity pool operator” is defined in the CEA as any person engaged in the commodity pool business who solicits, accepts or receives from others, funds, securities or property, either directly or through capital contributions, the sale of stock or other forms of securities, for the purpose of trading in commodity interests. In the context of any private fund that is a commodity pool, the fund sponsor/manager is typically a commodity pool operator under the CEA.
[v] For a discussion of issues related to the “reasonable verification steps” requirement of Rule 506(c), please see our prior Securities Alerts referred to in endnote iii above and at http://www.whiteandwilliams.com/resources-alerts-Rule-506c-General-Solicitation-Offerings-SEC-Issues-Additional-Guidance-on-Investor-Verification.html