A post on DealBook pointed me to a recent SEC release I missed over the holidays. The proposed rules contained in the release “are designed to provide additional investor protections” with respect to hedge funds. The proposed rules include amendments to Regulation D that change the definition of accredited investor to be applied to a natural person with respect to an investment in a “private investment vehicle,” i.e., hedge fund. Under the proposal, for a natural person hedge fund investor to be considered accredited (what the release refers to as an “accredited natural person”), he or she would need to meet the existing definition of accredited investor under Rule 501(a)(5) or (6) (i.e., net worth of at least $1,000,000, annual income of at least $200,000, or joint annual income of at least $300,000) and own at least $2.5 million in investments. Note that it appears a hedge fund would still be able to take money from up to 35 non-accredited investors as allowed under Rule 506 provided it furnishes them the requisite disclosure and believes the investors are sophisticated (although, it seems highly unlikely that a hedge fund would bother with non-accredited investors (many funds have seven-figure minimum investment requirements), and I would view it as a red flag if it did (it can’t attract the smart money)).

I have not studied the release in depth, but one interesting thing of note is that the proposal provides that the $2.5 million threshold will be adjusted every five years for inflation, which is not the case for the $1,000,000/$200,000/$300,000 thresholds referenced above. These thresholds, as the release notes, have remained unchanged since the SEC established them in 1982. Putting aside “nanny state” criticisms referenced in the DealBook post, it strikes me as curious that the SEC would include an inflation adjuster in this new threshold yet say nothing about adding one for the old thresholds. Maybe it has something in the works.

[Have you noticed that this is the most action we've had in a single day on this blog in a long time? Perhaps Frank has emboldened us TOTMers.]

Similar to Gretchen Morgenson’s recent attack on Rule 144A offerings (discussed by Larry Ribstein here), page C1 of yesterday’s W$J assails PIPE offerings (see here). PIPE stands for “private investment in public equity” and is a financing technique used by many small and mid-size public companies. In a typical PIPE, a company privately negotiates a sale of unregistered equity or equity-linked securities to institutional investors. As part of the deal, the company agrees to register the resale of the equity securities, typically within 30 days. The securities are priced at a discount to the applicable public market price to reflect the fact the original issuance is unregistered. PIPEs offer a number of advantages as a financing technique, including quick time to market (no pre-offering delay for SEC filings, abbreviated documentation) and an equity financing option for companies with market caps or deal sizes too small for a registered equity follow-on offering.

The Journal article, however, does not focus on the advantages of PIPE deals. Instead, it seems to try to vilify them. The article begins by talking about a lawyer who pleaded guilty to conspiring to commit securities fraud and then notes that PIPEs are referred to as “toxic converts” and “death-spiral financings.” But it fails to point out that these labels only apply to PIPE deals involving the issuance of convertible securities where the conversion price floats with the market price of the company’s common stock. Many, many PIPE deals do not involve this feature. The article also decries the fact that hedge funds are investing in PIPEs and “often start shorting the company’s stock even before the financing deal is signed or publicly announced.” This is bad according to the article because hedge funds “are simply looking to profit from the short sales, rather than help the company’s prospects.” Shocking!!!

The real importance of PIPEs, which the article mentions but certainly doesn’t highlight, is that they provide an option for many companies that otherwise would be unable to secure financing. Sure the terms may sometimes be onerous or even toxic, but at least the alternative is there for the board to consider. Bottom line: notwithstanding the Journal article, there is nothing inherently wrong PIPE deals.