In April, the president signed the Jumpstart Our Business Startups (JOBS) Act in an effort to enable private capital formation and reduce regulatory and reporting obligations for “emerging growth companies.” The legislation includes the “IPO On-Ramp,” which relaxes emerging growth companies’ reporting obligations under Sarbanes-Oxley, as well as provisions that increase the offering amount under which certain small company financings are exempt from registration.
Additional provisions within the JOBS Act present investment advisors with a number of new challenges and opportunities for high-net-worth clients, as the legislation increases investor visibility and access to several alternative private investment structures.
Simply put, non-accredited investors will be able to invest alongside higher net worth angels under the new “crowdfunding” provisions in which groups of people pool small individual investments in startups and other early-stage ventures. (For more on crowdfunding regulations, see “SEC, NASAA Tell Small Businesses: Wait to Join the ‘Crowd’.") The Act allows non-reporting issuers to raise up to $1 million within any 12-month period through a broker or “funding portal” that meets certain conditions.
Venture populists and those who advocate that net worth is a poor measure of sophistication, and that all investors should have a level playing field with respect to access to private investment offerings, hail the crowdfunding provision as a step forward in investor rights. Advisors can expect to have more conversations in the near future with their non-accredited investor clients about the merits of specific startup small business investment offerings and venture investment in general.
The Act does cap the maximum crowdfunding investment per investor at the greater of $2,000 or 5% of the investor’s annual income or net worth (if the investor’s annual income or net worth is less than $100,000), and 10% of the investor’s annual income or net worth, capped at $100,000 (if the investor’s annual income or net worth is $100,000 or greater). These caps, viewed as being excessive by some, do provide some comfort to those who advocate in favor of investor protection clauses that non-accredited investors not overexpose themselves to riskier venture opportunities.
Similarly, advisors should prepare to engage in many more discussions with their HNW accredited investor clients about hedge funds, managed futures and other privately-issued alternative investment fund products. Title II of the JOBS Act requires the SEC to amend Regulation D to drop the recession-era prohibition on “general solicitation and advertising” for private offerings under Rule 506, as long as all of the investors in those funds are accredited.
Hedge funds, pending guidelines to be drafted by the SEC early this summer, will soon be advertising their offerings in all forms of media. Invariably, HNW investors will be exposed to a wide range of new investment product offerings. Advisors who embrace alternative investments will need to ramp up their knowledge base through online hedge fund information and research portals such as All About Alpha and HedgeWorld and familiarize themselves with private offering protocols of their custodians and clearing firms.
The SEC has to deliver guidelines and clarifications that will likely further alter the implications of the JOBS Act to investors. I expect the mutual fund industry will lobby to ensure that considerable restrictions are imposed upon private fund issuers with respect to the manner in which hedge funds will be required to advertise performance. In my opinion, that makes good sense.
Additionally, so-called investor protection advocates may prevail in ascribing a more restrictive definition of an accredited investor. Recently, the accredited bar was raised by excluding the equity in one’s home from the $1 million net worth requirement. The annual income requirement, which was left unchanged at $200,000 for an individual and $300,000 for a couple, may be revised higher. That would be a mistake that would violate the spirit of the legislation and would have a contrary and chilling effect on easing private capital formation.
Such that investors will have greater access to alternative investments like venture capital and hedge funds, progressive wealth managers and investment advisors have an exciting new opportunity in front of them that can not only further diversify their client’s portfolios, but also grow their client base and firm’s profile.