As we all know by now, the Jumpstart Our Business Startups Act (the “JOBS Act”) created new exemptions not only from the registration requirements of the Securities Act of 1933, as amended, but also from the reporting requirements under the Exchange Act of 1934, as amended. These reporting requirements require issuers to file regular 8Ks, 10Qs, and 10Ks, and the compliance burden can be costly. Because of the costs of compliance, these reporting obligations traditionally are something that private issuers of securities have tried to avoid.
In the investment fund world, managers limit sales of securities solely to “accredited investors” (to sell securities under the old Rule 506 exemption from the registration requirements of the Securities Act), but also sometimes would limit the persons who could invest to “qualified purchasers” (defined in Section 2(a)(51) of the Investment Company Act of 1940 as individuals with a net worth of at least $5 million, or business entities having a net worth of at least $25 million (or owned solely by other qualified purchasers)). Investment funds relying on the Section 3(c)(1) exemption from the definition of “investment company” in Section 3(a) of the Investment Company Act of 1940 could sell interests in the fund to a maximum of 100 accredited investors without regard to the investor’s status as a “qualified purchaser”. Section 3(c)(7) provided a very similar exemption to Section 3(c)(1); provided however, that if the only purchasers of securities were “qualified purchasers”, the fund could accept up to 500 investors before being subject to the reporting obligations under the Exchange Act.
The JOBS Act amended Section 12(g)(1) of the Exchange Act to require an issuer to register a class of equity securities if the issuer has total assets of more than $10 million and a class of equity securities “held of record” by either (i) 2,000 persons, or (ii) 500 persons who are not accredited investors. The prior threshold (before the JOBS Act) had been 500 holders of record without regard to accredited investor status, and that provision created the 500-investor limit on Section 3(c)(7) funds. Now, Section 3(c)(7) funds (funds selling interests solely to qualified investors) can accept up to 2,000 investors without having to be subject to the Exchange Act’s reporting requirements. Unfortunately, the limit in Section 3(c)(1) (100 accredited investors) remains unchanged.
For a real estate fund, other exemptions from the definition of “investment company” exist. Under Section 3(c)(5) of the Investment Company Act, a person who is primarily engaged in purchasing or otherwise acquiring mortgages and other liens on, and interests in (i.e., fee simple), real estate are also exempted. In that case, a real estate fund relying on the Section 3(c)(5) exemption could accept up to 2,000 investors (all of whom are accredited), or 500 if they are not accredited investors, and remain exempt from the Exchange Act reporting requirements.
There are limits on the number of non-accredited investors that may invest if the issuer is relying on Rule 506(b), but there is another exemption created by the JOBS Act, namely, the exemption found in revised Regulation A, that allows for
• advertising and general solicitation in connection with the sale of securities, and
• sales to up to 500 non-accredited investors.
While there are limits on the amount a non-accredited investor could invest, the minimum under Regulation A is always at least $5,000. How would you like $2,500,000 raised from non-accredited (and accredited) investors through a Regulation A “mini-IPO” for an open-end REIT?