February 27, 2002
Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
File No. S7-23-01 - Defining the Term "Qualified Purchaser" under the Securities Act of 1933
Dear Mr. Katz:
Managed Funds Association (MFA) is filing comments in connection with the Securities and Exchange Commission's (SEC or Commission) notice of proposed rulemaking entitled "Defining the Term "Qualified Purchaser" under the Securities Act of 1933" which appeared in the Federal Register on December 27, 2001.1 MFA strongly supports the proposed definition of the term "qualified purchaser" under the Securities Act of 1933 which would be identical to that of "accredited investor" under SEC Regulation D2. In addition, MFA strongly supports the SEC adopting a new, uniform federal rule similar to the NASAA Model Accredited Investor Exemption3 (MAIE) for all Regulation D offerings, not just Rule 504 offerings.
MFA is the global voice of the alternative investment industry. MFA, located in Washington, D.C., is a membership organization dedicated to serving the needs of the professionals who specialize in the global alternative investment industry - hedge funds, funds of funds and private and public managed futures funds. MFA has over 600 members. Our members represent a significant portion of the $500 billion invested in alternative investment vehicles around the world. MFA members include many of the largest international financial services conglomerates and are based in both the U.S. and Europe.
With the enactment of the National Securities Markets Improvement Act of 1996 4 (NSMIA), Section 18 of the Securities Act of 1933 was amended to exempt from State regulation and registration seven (7) classes of "covered securities." The Commission's current proposal would define the class of securities which are "offered or sold to qualified purchasers." The Commission proposes to define the term "qualified purchaser" similarly to that of "accredited investor" under SEC Regulation D.
MFA believes the Commission's proposed definition of "qualified purchaser" as equaling that of "accredited investor" under Rule 501(a) of Regulation D is appropriate and accomplishes Congress' intention in adopting NSMIA. MFA, however, believes that rather than creating a new term under the 1933 Act that has a different meaning under the 1940 Act, the term "accredited investor" should be utilized to avoid any confusion by the investing public. The SEC is in a particularly good position to make this determination due to the fact that its definition of "accredited investor" in Regulation D has been in use for over 20 years. In addition, the standard is well known to practitioners, investors and issuers. We agree with the Commission's analysis that other common terms applied to financially sophisticated investors such as "qualified institutional buyer," "qualified purchaser," "qualified client" and "qualified investor," would be much more restrictive than "accredited investor" and for that reason would likely be contrary to Congress' intent of simplifying and streamlining the securities registration process which is integral to the capital formation process.5 Further, we agree with the Commission that there is no reason to create a "new" definition for "qualified purchaser" under the 1933 Act. It is our opinion that there are too many similar, but different, statutory and regulatory standards for sophisticated investors in our federal securities laws today. As was noted in the preamble, the Congressional intent behind NSMIA was toward simplification and clarity, which will be accomplished through the use of a well known term such as "accredited investor."6
In the release, the Commission proposes two alternative approaches to preserving the ability of issuers to offer and sell to accredited investors without the need to register the offerings.7 The two options are: (1) excluding "accredited investors" purchasing in a public Rule 504 offering from the definition of "qualified purchaser," or (2) creating a new, uniform federal accredited investor exemption. MFA strongly supports adoption of alternative (2) - a new, uniform federal accredited investor exemption.
NASAA Model Accredited Investor Exemption
In April 1997, NASAA released its Model Accredited Investor Exemption (MAIE) for States to review and adopt.8 The MAIE provides a State securities law registration exemption for securities which are sold only to "accredited investors." MAIE also permits securities meeting the exemption requirements to engage in limited public advertising. Issuers would generally be permitted to include information permitted under SEC Rule 134, the "tombstone ad" rule.9
In just five (5) years since the MAIE was released, 40 States have adopted MAIE in one form or another. MAIE has become, in essence, a "federal rule" through its broad adoption and sets a national standard. MFA would like to congratulate NASAA and the States on achieving such broad-based adoption of MAIE. MFA believes that this proposal by the organization representing State securities administrators is well conceived and properly balances investor protection concerns with promoting capital formation. It is clear that securities which are sold only to sophisticated investors such as "accredited investors" require less regulation than securities which are sold to less sophisticated investors. The time has come for the SEC to adopt such a widely known and widely adopted rule which enjoys the strong support of 40 States.
MFA strongly encourages the SEC to proceed with establishing a new, uniform federal accredited investor exemption which is modeled on MAIE. While we consider MAIE to be a "federal rule" through its broad adoption by 40 States, there is a real need for a uniform federal rule to insure consistency through federal preemption. As is pointed out in the preamble, there is a lack of uniformity between the States in terms of the exact definitions and requirements of the versions of MAIE which have been adopted in the 40 States. This lack of uniformity creates additional legal and compliance costs for issuers seeking to make an offering in multiple States at one time, without providing additional investor protection. Congress clearly wanted to lower unnecessary regulatory costs and promote capital formation when it included securities sold to "qualified purchasers" as a class of "covered securities." A new, uniform federal rule modeled on MAIE which applies to all Regulation D offerings, not just Rule 504 "seed capital offerings," would accomplish this goal.
MFA Recommendations for Federal MAIE
MFA strongly supports the adoption of a new, uniform federal rule modeled on MAIE. There are several issues which MFA believes are very important for the new, uniform federal rule to be effective and carry out the intent of Congress in NSMIA. The first issue is that the new, uniform federal rule should apply to all Regulation D offerings, not just Rule 504 offerings. As the Commission knows, private placements occurring under Rules 505 and 506 are also restricted to "accredited investors."10 To the extent the Commission believes that it is "the nature of the investor rather than the investment (which) is the critical feature . . . "11 there appears to be no good reason for the new, uniform federal MAIE rule to not apply to all Regulation D offerings, at least to the extent the issuers will restrict their sales solely to "accredited investors." We note that the MAIE is not limited to Rule 504 type offerings. Further, we believe it would be inconsistent with Congressional intent in enacting NSMIA to limit application of this new, uniform federal MAIE rule to just Rule 504 offerings which are made to "accredited investors" when other Regulation D offerings are made to the same types of sophisticated investors.12
The second issue MFA believes is very important to an effective new, uniform federal MAIE exemption is a clear provision permitting issuers to publish tombstone ads. As noted in the preamble to the proposed rule, the NASAA MAIE provides issuers with the explicit authority to engage in limited public advertising. The advertising provision is similar to the "tombstone ad" provision found in SEC Rules today.13 MFA strongly supports explicit advertising authority under the new, uniform federal MAIE. For the sake of uniformity, we would support incorporating by reference the "tombstone ad" rule provisions. Further, MFA would support adding a requirement that such ads include a legend such as "These securities will be sold only to Accredited Investors."
There are two subissues related to tombstone ads under a new, uniform federal MAIE on which the SEC should carefully consider. First, the SEC should make it clear that it does not consider tombstone ads under the new rule to be "general solicitations." Obviously issuers using Regulation D are attempting to engage in "private placements" which are exempt from registration under Section 4(2) of the Securities Act of 1933.14 In the past, any advertising in publications of general distribution could constitute a "general solicitation" and disqualify the offering from qualifying as a "private placement." The sanctions under the federal securities laws for making a public offering without registration of the securities are significant. MFA believes that issuers which are restricting the sale of their securities only to accredited investors should be permitted to utilize tombstone ads to reach their intended audience and that such advertising authority should be unequivocal. Clearly these issuers should not be permitted to sell their securities to non accredited investors. The SEC should make it very clear that issuers meeting the requirements of the new, uniform federal MAIE are permitted to publish "tombstone ads" in publications of general distribution without such ads being considered "general solicitations."
The second subissue related to tombstone advertising under the new, uniform federal MAIE would be making it clear that such ads are not a statutory "prospectus."15 Again, issuers (and their counsel) who are eligible for the new, uniform federal MAIE will want this issue addressed clearly by the SEC due to the potential liability and sanctions. The SEC has taken the position that tombstone ads are not statutory "prospectuses."16 We believe the SEC should take the same position for "tombstone ads" which are permitted under the new, uniform federal MAIE and make it very clear in the rule that such ads will not be considered to be statutory "prospectuses."
The third issue MFA believes is important is stock purchases by "knowledgeable employees" as defined under the 1940 Act.17 The new, uniform federal MAIE would prohibit the sale of securities to any person who does not meet the definition of "accredited investor." MFA believes that this is an appropriate restriction for sales to individuals who do not work for the issuer. We believe, however, that it would be very important for any new federal rule in this area to make it clear that sales to individuals meeting a definition similar to that of "knowledgeable employee"18 should be permissible. Individuals who work for the issuer are more familiar with the issuer's operations than other types of investors and should be permitted to purchase these securities, even if they do not qualify as "accredited investors."
MFA has other comments regarding a new, uniform federal MAIE. We believe that there should be some issuer requirements for being able to utilize a new, uniform federal MAIE. We oppose requiring the issuer to be an Exchange Act reporting company, as this would severely limit the number of small entities which could avail themselves of the rule. In our view, that would be contrary to Congress' intent in NSMIA. We would support, however, prohibiting issuers who are considered to be "blank check" companies or those issuers with management or insiders with statutory disqualifications from being able to use the rule as these limits would promote investor protection.
Public Managed Futures Fund Offerings
Under Section 102(b) of NSMIA, the SEC was directed to conduct a study regarding the uniformity of state regulatory requirements for securities which are not "covered securities." In August 1997 the SEC received comments regarding the significant burdens of State Blue Sky registration and regulation of the SEC 1933 Act registered securities of a managed futures funds. The "Uniformity Study" was published by the SEC in October 1997.19
MFA requests that the Commission act to provide SEC 1933 Act registered managed futures fund securities with "covered securities" status. Under Section 18 of NSMIA there are seven (7) separate classes of "covered securities." 20 Among the "covered securities" are the securities issued by registered investment companies.21 Under this provision, the States may not require registration of the securities sold by SEC registered and regulated investment companies. This exemption is quite logical in that the securities have been registered and reviewed by the SEC under the Securities Act of 1933.
MFA requests that the SEC provide the same treatment to the SEC registered and reviewed securities of managed futures funds. There are several publicly offered managed futures funds in the United States today. These funds are sponsored by large, well-known broker dealers such as Merrill Lynch; Morgan Stanley Dean Witter; Prudential and Salomon Smith Barney. The operator of a managed futures funds is registered and regulated as a commodity pool operator with the Commodity Futures Trading Commission under the Commodity Exchange Act.22 These funds are primarily engaged in the business of investing in futures, not securities, and for this reason are not required to be registered with the SEC under the Investment Company Act of 1940. The securities issued to the public by such funds are, however, registered with and reviewed by the SEC under the Securities Act of 1933. The SEC review is in addition to the CFTC staff review of the offering documents, which must meet the extensive detailed disclosure requirements under CFTC regulations.23 Further, all marketing materials for such securities are subject to NASD review.
Despite dual federal regulation, both of the company and the securities being issued, public managed futures fund securities are subjected to State Blue Sky registration and regulation while registered investment companies securities are not. As the SEC knows, the cost of State Blue Sky registration and regulation can be quite expensive and time consuming and accordingly a major impediment to the efficiency of the U.S. capital markets. We believe the exemption provided to the securities of registered investment companies was entirely appropriate due to SEC registration and review. MFA believes that the securities of public managed futures funds - which are registered with and reviewed by the SEC under the Securities Act of 1933 - should be accorded the same treatment which registered investment company securities receive. MFA requests that the SEC exercise its authority to exempt the securities of public managed futures funds from State Blue Sky registration and regulation. MFA's proposal would eliminate overlapping regulation and the costs that duplicate regulation creates.
If you have any questions or comments please contact me at (202) 367-1140.
John G. Gaine
|1||See 66 Fed. Reg. 66839 to 66847 (Dec. 27, 2001).|
|2||17 C.F.R. 230.501(a).|
|3||CCH NASAA Reporter Para 361|
|4||Pub. L. No. 104-290, 11 Stat. 3416 (Oct. 11, 1996).|
|5||66 Fed. Reg. 66841-66842.|
|6||Some commentators have suggested that the annual income ($200,000 each year for last two years and reasonable expectation of the same for current year) or net worth levels ($1 million) for natural persons under "accredited investor" standard should be increased. Inflation can, and does, erode the meaningfulness of nominal annual income and net worth levels. While it is outside the scope of the current rulemaking, MFA would support the Commission proposing indexing the annual income and net worth test for inflation on a going forward basis.|
|7||66 Fed. Reg. at 66844.|
|8||See fn. 3 supra.|
|9||17 C.F.R. Section 230.134|
|10||Regulation D currently permits up to 35 "non accredited" investors to participate in a private placement. See 17 C.F.R. 230.502.|
|11||66 Fed. Reg. at 66845.|
|12||We note that Rule 506 offerings are among the seven (7) "covered securities" added to Section 18 through NSMIA and are therefore exempt from State registration and regulation. For this reason, it appears clear that including all other Regulation D offerings within the new, uniform federal MAIE would be consistent with Congressional intent.|
|13||17 C.F.R. Section 230.134|
|14||15 U.S.C. Section 77d(2).|
|15||15 U.S.C. Section 77b(10).|
|16||See L. Loss, Fundamentals of Securities Regulation 108 (Little, Brown 2d ed. 1988)|
|17||17 C.F.R. Section 270.3c-5.|
|19||"Report on the Uniformity of State Regulatory Requirements for Offerings of Securities that are not "Covered Securities"" U.S. Securities and Exchange Commission (October 1997).|
|20||15 U.S.C. 77r(b).|
|21||15 U.S.C. 77r(b)(2).|
|22||7 U.S.C. Section 6.|
|23||See 17 C.F.R. Part 4.24 - 4.26.|