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Fund Sponsor Violated Private Offering Rules

The sponsor of a private fund agreed to disgorge its management fees for soliciting investors without a pre-existing, substantive relationship.  The SEC accuses the fund sponsor and its principal with engaging in a public solicitation through a website and media interviews.  The respondents had filed a Form D Notice of a private offering.  The alleged public solicitation violated Section 5 of the Securities Act, which requires a registration statement before engaging in a public offering.  During the unlawful offering, the value of the fund declined 62%, which amounted to over $300,000.  The Order notes that the principal had no prior securities industry experience. The SEC declined to impose further penalties because of the respondents’ financial condition.

Most securities professionals know that you cannot raise capital in a private offering unless the offeror can document a pre-existing relationship with potential investors.  However, as FinTech and the securities markets intersect, the neophytes may not realize that they are tripping over the regulatory wires.  This respondent is lucky that the SEC didn’t order full rescission of the offering and the refund of the amount lost. 

SEC Chairman Attacks “Accredited Investor” Concept

In a recent speech SEC Commissioner and acting Chairman Michael Piwowar argued that the SEC should dispense with the “accredited investor” definition for private offerings.  He asserted that the “artificial distinction” between “accredited” and “non-accredited” investors hurts lower-income investors because they are deprived of higher-yielding investments that offer portfolio diversification.  He maintained that this artificial distinction does more harm than good by “exacerbating inequalities of wealth and opportunity.”   In the same speech, Mr. Piwowar also questioned corporate penalties but not against advisers and broker-dealers, which are regulated entities whose shareholders should fully understand the regulatory risk to the stock price.

OUR TAKE: Back in 2013, the SEC changed Rule 506 to allow general solicitation so long as issuers only targeted “accredited investors.”  (See “SEC Allows Private Fund General Solicitation with Conditions”).  Mr. Piwowar’s suggestion to eliminate the “accredited investor” definition, thereby opening private funds to retail investors, would have far-reaching implications for fund-raising, compliance, and civil litigation.