Embed Size (px)
Citation preview
Private Fund Securities Law Exemptions: Accredited Investors, Qualified Purchasers, Subscription Limits, and MoreNavigating Exemptions Under the Investment Adviser, Securities, Exchange, and Investment Company Acts
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
The audio portion of the conference may be accessed via the telephone or by using your computer's
speakers. Please refer to the instructions emailed to registrants for additional information. If you
have any questions, please contact Customer Service at 1-800-926-7926 ext. 1.
WEDNESDAY, MARCH 25, 2020
Presenting a live 90-minute webinar with interactive Q&A
Genna Garver, Partner, Troutman Sanders, New York
Gregory J. Nowak, Partner, Pepper Hamilton, New York & Philadelphia
Tips for Optimal Quality
Sound Quality
If you are listening via your computer speakers, please note that the quality
of your sound will vary depending on the speed and quality of your internet
connection.
If the sound quality is not satisfactory, you may listen via the phone: dial
1-877-447-0294 and enter your Conference ID and PIN when prompted.
Otherwise, please send us a chat or e-mail [email protected] immediately
so we can address the problem.
If you dialed in and have any difficulties during the call, press *0 for assistance.
Viewing Quality
To maximize your screen, press the ‘Full Screen’ symbol located on the bottom
right of the slides. To exit full screen, press the Esc button.
FOR LIVE EVENT ONLY
Continuing Education Credits
In order for us to process your continuing education credit, you must confirm your
participation in this webinar by completing and submitting the Attendance
Affirmation/Evaluation after the webinar.
A link to the Attendance Affirmation/Evaluation will be in the thank you email
that you will receive immediately following the program.
For additional information about continuing education, call us at 1-800-926-7926
ext. 2.
FOR LIVE EVENT ONLY
Program Materials
If you have not printed the conference materials for this program, please
complete the following steps:
• Click on the link to the PDF of the slides for today’s program, which is located
to the right of the slides, just above the Q&A box.
• The PDF will open a separate tab/window. Print the slides by clicking on the
printer icon.
FOR LIVE EVENT ONLY
Private Fund Securities Law Exemptions: Accredited Investors,
Qualified Purchasers, Subscription Limits and More
Genna Garver and Gregory J. Nowak
Private Fund Securities Laws
• Securities Act of 1933
• Investment Company Act of 1940
• Securities Exchange Act of 1934
• Investment Advisers Act of 1940
• State statutory counterparts, subject to NSMIA preemption
• Securities laws of applicable foreign jurisdictions (e.g., Europe’s AIFMD)
6
Securities Act of 1933
• Prohibits the offering or sale of securities unless a registration statement has been filed or an exemption is available.
• “Securities” is broadly defined to include stock and note (debt) instruments.
• Applies to transactions in securities involving the use of the U.S. mails or interstate commerce.
7
33 Act – Common Exemptions
• Section 4(a)(2)
• Regulation D Safe Harbor
• Regulation S Safe Harbor
• JOBS Act Offerings – (i.e., “private placements in the context of a general
solicitation” – only verified accredited investors can invest)
8
33 Act – Section 4(a)(2)
• Section 4(a)(2)– Transactions not involving any public offering– Public offering not defined– To qualify for this exemption, which is sometimes referred to as the
“private placement” exemption, the purchasers of the securities must:
• either have enough knowledge and experience in finance and business matters to be “sophisticated investors” (able to evaluate the risks and merits of the investment), or be able to bear the investment's economic risk
• have access to the type of information normally provided in a prospectus for a registered securities offering and
• agree not to resell or distribute the securities to the public
– In general, public advertising of the offering, and general solicitation of investors, is incompatible with the “private placement” exemption.
9
33 Act – Regulation D
• Regulation D Safe Harbor—Commonly Used Provisions
– 506(b)—limited offers without regard to $ amount
• Up to 35 non-accredited investors
• No general solicitation or general advertising
– 506(c)—JOBS Act Provision
• All verified accredited investors
• General solicitation and general advertising permitted
10
33 Act Regulation D
• Practical Tips
– Use of 506(c) and general advertising will not permit you to stop advertising and convert the offering to 506(b)
– Regulation D requires you to file Form D with the SEC and with certain states, depending on if a state exemption is available
– Failure to file Form D will not invalidate the exemption at either the Federal or state level (but
would preclude a JOBS Act offering under Rule 506(c))
11
33 Act – Federal preemption
• The Securities Act of 1933 preempts state law for “covered” securities.
• “Covered” securities include offerings made pursuant to Regulation D; but not offerings made pursuant to 4(a)(2).
• Offerings made pursuant to 4(a)(2) will need a state level exemption in each state where the securities will be offered and sold.
12
33 Act – Accredited Investors –Current Definition
• Accredited Investors– Current definition includes any person who falls within
one of the categories below or whom the issuer reasonably believes falls into one of these categories:• any natural person whose individual net worth, or joint with
spouse, exceeds $1,000,000, excluding the primary residence and any indebtedness secured thereby
• any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 and has a reasonable expectation of reaching the same income level in the current year
13
33 Act – Accredited Investor Verification
• The issuer is required to take “reasonable steps” to verify the accredited investor status of the purchasers.
• Rule 506(c)(2)(ii) sets forth non-exclusive and non-mandatory accredited investor verification methods that, if satisfied, serve as safe harbors for issuers who will be deemed to have satisfied the “reasonable steps” verification requirement. – Reviewing any Internal Revenue Service (IRS) form reporting a purchaser’s income for the two most
recent fiscal years and obtaining a written purchaser representation that he or she has a reasonable expectation of reaching the required income level during the current year
– Reviewing specified documentation evidencing the purchaser’s assets and liabilities dated within the prior three months and obtaining a written purchaser representation that all liabilities necessary to make a determination of net worth have been disclosed.
• As what constitutes “reasonable steps” is a principles-based determination, an issuer that does not satisfy any of the verification safe harbors can still satisfy the reasonable steps requirement using other verification methods.
14
33 Act – Accredited Investors –Proposed Amendment to Definition
• New categories of natural persons:– certain professional certifications or designations or other credentials– Private fund “knowledgeable employees”
• Expands list of entities: – SEC and state RIAs– Rural Business Investment Companies– LLCs with total assets in excess of $5 million not formed for the
specific purpose of acquiring the securities being offered– Entities meeting an investments-owned test
• Adds Family offices with at least $5 million in AUM and their family clients
• Adds the terms “spousal equivalent”See SEC Release No. 33-10734 (December 18, 2019 )
15
33 Act – Bad Actor Disqualification
• As a result of Rule 506(d) bad actor disqualification, an offering is disqualified from relying on Rule 506(b) and 506(c) of Regulation D if the issuer or any other person covered by Rule 506(d) has a relevant criminal conviction, regulatory or court order or other disqualifying event that occurred on or after September 23, 2013, the effective date of the rule amendments. Under Rule 506(e), for disqualifying events that occurred before September 23, 2013, issuers may still rely on Rule 506, but will have to comply with the disclosure provisions of Rule 506(e)
16
33 Act – Bad Actor Disqualification
• Certain persons are covered by the bad actor disqualification “Covered persons” include:– the issuer, including its predecessors and affiliated issuers
– directors, general partners, and managing members of the issuer
– executive officers of the issuer, and other officers of the issuers that participate in the offering
– 20 percent beneficial owners of the issuer, calculated on the basis of total voting power
– promoters connected to the issuer
– for pooled investment fund issuers, the fund’s investment manager and its principals
– persons compensated for soliciting investors, including their directors, general partners and managing members
17
33 Act – Bad Actor Disqualification
• Under the Rule, certain events are considered disqualifying events for bad actors. They include:– Certain criminal convictions
– Certain court injunctions and restraining orders
– Final orders of certain state and federal regulators
– Certain SEC disciplinary orders
– Certain SEC cease-and-desist orders
– SEC stop orders and orders suspending the Regulation A exemption
– Suspension or expulsion from membership in a self-regulatory organization (SRO), such as FINRA, or from association with an SRO member
– U.S. Postal Service false representation orders
• Many disqualifying events include a look-back period (for example, a court injunction that was issued within the last five years or a regulatory order that was issued within the last ten years) . The look-back period is measured from the date of the disqualifying event and not the date of the underlying conduct that led to the disqualifying event.
18
33 Act – General Solicitation
• General Solicitation– Two Types of Regulation D offerings
• Rule 506(b) offerings, which cannot use general solicitation but in which non-accredited investors can participate so long as they are provided with extensive information about the issuer of the securities, usually in the form of a private placement memorandum
• Rule 506(c) offerings, which can use general solicitation, but must be sold to accredited investors only, in which the market will let investors dictate the type of information that they need in order to make informed investment decisions
19
33 Act – General Solicitation
• SEC Rule 502(c) does not define General Solicitation but does provide examples of it.– Neither the issuer nor any person acting on its behalf shall
offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following:
• (1) Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio
• (2) Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising
20
33 Act – General Solicitation
• SEC guidance explains the Rule 502(c) ban can be understood by asking two separate questions about a communication:
• Is the issuer or someone acting on its behalf using the communication to offer or sell securities?
• Is the communication a general solicitation or general advertisement?
– SEC guidance explains that a communication does not violate the Rule 502(c) ban if either of these questions can be answered in the negative.
21
33 Act – Regulation S
• Regulation S Safe Harbor
– Regulation S provides an exclusion from registration for offerings made outside the United States by both U.S. and foreign issuers
– A securities offering, whether private or public, made by an issuer outside of the United States in reliance on Regulation S need not be registered under the 33 Act.
– The Regulation S safe harbors are non-exclusive, meaning that an issuer that attempts to comply with Regulation S also may claim the availability of another applicable exemption from registration.
– Regulation S is available for offerings of both equity and debt securities.
– Deemed offshore if no directed selling efforts in U.S.
– Non-U.S. investors must receive the PPM and must sign the Subscription Agreement outside the U.S.
– A fund can do simultaneous offerings under both Regulation D and Regulation S
22
Investment Company Act of 1940
• Prohibits “investment companies” from engaging in interstate commerce unless registered or exempt.
• “Investment companies”—any issuer which:– is or holds itself out as being engaged primarily, or proposes to engage
primarily, in the business of investing, reinvesting, or trading in securities;
– is engaged or proposes to engage in the business of issuing face-amount certificates of the installment type, or has been engaged in such business and has any such certificate outstanding; or
– is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer’s total assets (exclusive of Government securities and cash items) on an unconsolidated basis.
23
Common ICA Exclusions for Private Funds
• Section 3(c)(1) –– Any issuer whose outstanding securities are beneficially owned by not
more than 100 persons and who does not make a public offering.
• Section 3(c)(7) –– Any issuer, the outstanding securities of which are owned exclusively
by persons who, at the time of acquisition of such securities, are qualified purchasers, and who does not make a public offering.
• Reliance on other Section 3(c) exclusions– An issuer that qualifies for an exclusion in addition to those provided
by Section 3(c)(1) or 3(c)(7) may be treated as a “private fund”, provided that the issuer is treated as a private fund under the Investment Advisers Act and the rules thereunder for all purposes.
24
ICA Section 3(c)(1) Exclusion--Conditions
• Self-executing• All of the issuer’s outstanding securities must be beneficially owned by not more
than 100 hundred persons (or, in the case of a qualifying venture capital fund,* 250 persons)– No ICA financial qualifications, but other securities statutes may impose net worth or income
thresholds [NB: “accredited investor” and “qualified client” thresholds]; no restrictions on fund activities
– Beneficial ownership: the ability to decide whether or how much to invest
• The issuer must not be making and must not presently propose to make a public offering of its securities– An issuer will not be deemed to be making a public offering if its offering complies Securities
Act Section 4(a)(2) or the safe harbor under Securities Act Rule 506 of Regulation D
• *A “qualifying venture capital fund” means a venture capital fund as defined under the Investment Advisers Act that has not more than $10,000,000 in aggregate capital contributions and uncalled committed capital, with such dollar amount to be indexed for inflation once every 5 years
Note: an unregistered offshore fund can make a private offering in the US concurrently with a public offering outside the US and not violate section 7(d) if the offshore fund has no more than 100 beneficial owners resident in the U.S.
25
ICA Section 3(c)(1) Exclusion—Special Rules for Counting Beneficial Owners
• Count spouses who own jointly as one beneficial owner• Do not count a fund’s general partner or managing member as such
interests are not considered a security• Do not count those who are knowledgeable employees* at the time of
investment• Subject to the attribution “Look-through” rules, a “company” shall be
counted as one person (See ICA Section 3(c)(1)(A))• A transferee who acquired those interests pursuant to a gift, bequest or an
agreement relating to a legal separation or divorce will be deemed beneficially owned by the transferor under certain conditions (See ICA Section 3(c)(1)(B)l; Rule 3c-6)
• Don’t count non-U.S. investors in offshore funds• Don’t count U.S. residents in offshore funds if purchased in an offshore
secondary market purchase• Don’t double count the same person making multiple investments (i.e.,
through family trusts)
26
ICA Rule 3c-5—Beneficial Ownership by Knowledgeable Employees
Any natural person who is: • An executive officer, director, trustee, general partner, advisory
board member, or person serving in a similar capacity, of the fund or the fund’s affiliated investment manager; or
• An employee of the fund or the fund’s affiliated investment manager who:– Is not performing solely clerical, secretarial or administrative functions
with regard to such company or its investments;– In connection with his or her regular functions or duties, participates
in the investment activities of such fund, or other funds managed by that affiliated investment manager; and
– Has been performing such functions and duties for or on behalf of the fund or the investment manager, or substantially similar functions or duties for or on behalf of another company for at least 12 months.
27
ICA Section 3(c)(1)(A) Attribution “Look-through”
• If a company owns 10% or more of the outstanding voting securities of the issuer, and is or, but for the exceptions in Section 3(c)(1) or (7), would be an investment company, the beneficial ownership shall be deemed to be that of the holders of such company’s outstanding securities (other than short-term paper).– “Voting securities”
• interests or relationships that give a security holder the ability to control or influence a fund’s operations or management
• Interests in limited partnerships or limited liability companies that permit holders of those interests to remove or replace the general partner or managing member may be voting securities
• having a significant stake in a fund that effectively permits the holder to exercise control over a fund’s management may also be deemed a voting security
– ICA Rule 3c-2 permits SBIC funds to treat as a single beneficial owner a company that either (I) has not more than 5% of its assets invested in SBIC securities or (2) is a state development corporation and is not an investment company.
Other circumstances requiring “look-through”• ICA Section 48(a): “Look-through” required for multi-tired structures
– if the investor is organized specifically for the purpose of investing in the private fund--if the investing entity invests 40% or more of its assets in the section 3(c)(1) fund
• “Look-through” required if the investor is a device for facilitating individual investment decisions—if the individual owners of the investor can decide whether or how much of their own capital contribution to that entity may be invested in the private fund
28
Integration Doctrine
• The SEC will integrate two or more virtually identical private funds for determining compliance with Section 3(c)(1)’s 100 beneficial owner limit.– 3(c)(7) funds are not integrated with parallel 3(c)(1) funds; but feeder funds
will be deemed to be formed for the specific purpose of investing in a master and will be looked through for counting/qualifying. See ICA Section 3(c)(7)(E)
• Factors considered:– Do the entities share the same or similar investment objectives, investment
portfolios and risk/return characteristics?– Are the funds intended for the same group of investors?– Would a reasonable investor view the interests as not being materially
different?– Are the offerings part of a single plan of financing?– Do the offerings involve the same class of securities?– Are the offerings made at the same time?– Do the offerings involve the same type consideration?– Are the offerings made for the same general purpose?
29
ICA Section 3(c)(7) Exclusion--Conditions
• Self-executing• All of the issuer’s outstanding securities of must be owned
exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers”– No ICA limitations on quantity of investors, but Exchange Act Section
12(g) registration thresholds apply; no restrictions on fund activities
• The issuer must not be making and must not presently propose to make a public offering of its securities
– An issuer will not be deemed to be making a public offering if its offering complies Securities Act Section 4(a)(2) or the safe harbor under Securities Act Rule 506 of Regulation D
Note: an unregistered offshore fund can make a private offering in the US concurrently with a public offering outside the US and not violate section 7(d) if the all U.S. resident owners are qualified purchasers.
30
ICA Section 2(a)(51) –Definition of “Qualified Purchaser”
• Statutory definition:– (i) any natural person (including any person together with their spouse) who
owns not less than $5 million in “investments”– (ii) any company that owns not less than $5 million in “investments” and that
is owned directly or indirectly by or for 2 or more natural persons who are related as siblings or spouse (including former spouses), or direct lineal descendants by birth or adoption, spouses of such persons, the estates of such persons, or foundations, charitable organizations, or trusts established by or for the benefit of such persons;
– (iii) any trust that is not covered by clause (ii) and that was not formed for the specific purpose of acquiring the securities offered, as to which the trustee or other person authorized to make decisions with respect to the trust, and each settlor or other person who has contributed assets to the trust, is a person described in clause (i), (ii), or (iv); or
– (iv) any person, acting for its own account or the accounts of other qualified purchasers, who in the aggregate owns and invests on a discretionary basis, not less than $25 million in investments.
31
ICA Rule 2a51-1—Definition of “Investments”
• Securities, as defined by the Securities Act, other than securities of an issuer that controls, is controlled by, or is under common control with, the prospective Qualified Purchaser that owns such securities, unless the issuer of such securities is: – An investment vehicle; – A Public Company; or – A company with shareholders' equity of not less than $50 million (determined in accordance with generally
accepted accounting principles) as reflected on the company's most recent financial statements, provided that such financial statements present the information as of a date within 16 months preceding the date on which the prospective Qualified Purchaser acquires the securities of a Section 3(c)(7) Company;
• Real estate held for investment purposes; • Commodity Interests held for investment purposes; • Physical commodities held for investment purposes; • Financial contracts entered into for investment purposes; • In the case of a prospective Qualified Purchaser that is a Section 3(c)(7) company, a company that would
be an investment company but for the exclusion provided by Section 3(c)(1), or a commodity pool, any amounts payable to such prospective Qualified Purchaser pursuant to a firm agreement or similar binding commitment pursuant to which a person has agreed to acquire an interest in, or make capital contributions to, the Prospective Qualified Purchaser upon the demand of the prospective Qualified Purchaser; and
• Cash and cash equivalents (including foreign currencies) held for investment purposes:– Bank deposits, certificates of deposit, bankers acceptances and similar bank instruments held for investment
purposes; and – The net cash surrender value of an insurance policy.
32
“Qualified Purchaser”—Special Circumstances for Qualification
• Knowledgeable employees under ICA Rule 3c-5• Qualified institutional buyers (QIBs) under Securities Act Rule 144A acting on their
own account on the account of another QIB or the account of a qualified purchaser, with certain exceptions. See ICA Rule 2a51-1(g)(1)*
• A company formed for the specific purpose of acquiring the securities offered by a section 3(c)(7) company will not be a qualified purchaser unless each beneficial owner of the company's securities is a qualified purchaser. See Rule 2a51-3(a)
• A company may be deemed to be a qualified purchaser if each beneficial owner of the company's securities is a qualified purchaser. See Rule 2a51-3(b)
• A transferee who acquired those interests pursuant to a gift, bequest or an agreement relating to a legal separation or divorce from a qualified purchaser will be deemed to be a qualified purchaser under certain conditions. See ICA Rule 3c-6
• “Look-through” an IRA or self-directed account of a retirement plan to determine whether the participant is a qualified purchaser
33
“Qualified Purchaser”—Proposed Amendments to QIB Definition
• Expands list of entities:– Rural Business Investment Companies
– LLCs
– Institutional accredited investors not otherwise listed in the rule that satisfy the $100 million threshold
See SEC Release No. 34-87784 (December 18, 2019 )
34
Securities Exchange Act of 1934
• Regulates securities exchanges and over-the-counter markets operating in interstate commerce and through the U.S. mails.
• Requires Registration/periodic public reporting of financial data from Issuers at certain thresholds
• Governs use of third parties to find investors and/or portfolio company investments – i.e., use of SEC/FINRA registered Broker-Dealers
35
34 Act – Issuer Registration
• Section 12(g) establishes the thresholds at which an issuer is required to register a class of securities with the SEC.
• Thresholds for Registration
– Total assets exceeding $10M;
– 2,000 or more investors or 500 unaccredited investors
36
34 Act Broker-Dealer Registration
• Broker-dealer registration
– Section 15(a) makes it unlawful for a “broker” or a “dealer” to effect any transactions in or to induce or attempt to induce the purchase or sale of any security (other than an exempted security) unless such broker or dealer is registered with the SEC.
• Exemption: Section 3a4-1 – the “Issuer’s Exemption” is a safe harbor for the Issuer’s sales of its securities by Officers, Employees and other Associated Persons of the Issuer
37
34 Act – Broker Defined
• The term “broker” is defined as “any person engaged in the business of effecting transactions in securities for the account of others.”
– “engaged in the business” and “effecting transactions” are not defined terms
– SEC looks at various factors in determining if a participant is required to register as a broker
38
34 Act – Broker – Factors to Consider
• Transaction – based compensation: the single most important hallmark of broker status – any compensation relating to the success of the sale of the subject securities
• Soliciting securities transactions (significant investor contact and negotiation)
• Assisting an issuer to structure securities transactions
• Helping an issuer identify potential purchasers
• Participating in order-taking
• Previous securities registration
• Participating in the securities business regularly
39
34 Act – Issuer’s Exemption
• Rule 3a4-1 is a “non-exclusive safe-harbor” under which an “associated person” of an issuer that performs limited securities sales for the issuer as prescribed by the rule would be deemed not to be a “broker” under Section 3(a)(4). Must meet the following preliminary conditions.– The associated person must not be subject to a statutory disqualification, as defined in
Section 3(a)(39) of the Exchange Act, at the time of his or her participation in the sale of the issuer’s securities
– The associated person must not be compensated in connection with the sale of the issuer’s securities by the payment of commissions or other remuneration based either directly or indirectly on transactions in securities
– The associated person must not be an associated person of a broker or dealer at the time of the sale
• An issuer may only use this exemption once in a 12 month period.
40
34 Act Issuer’s Exemption
• In addition to satisfying each of the preliminary conditions, one of the following three sets of conditions must be satisfied in order for the safe harbor to apply
– Sales Restricted to Certain Classes of Purchasers or Certain Transactions
– Sales Duties Are Limited in Frequency and Proportion
– Sales Duties Are Passive
41
34 Act – Potential Pitfalls
• The Issuer’s Exemption is not an automatic exemption – could turn into unregistered broker activity easily
• The issue of an unregistered entity receiving transaction based compensation has been on the SEC’s radar for the last several years- Ranieri Partners Case
- David Blass Speech
- Blackstreet Case
42
34 Act – Ranieri Partners Case
• In March 2013, the SEC alleged a violation of 15(a), acting as an unregistered broker for marketing and receiving placement fees for the sale of interests in two real estate funds organized and advised by Ranieri Partners. The settlement orders cite a number of factors as support for this allegation, including receiving “transaction-based compensation” totaling approximately $2.4 million.
• The SEC concluded that the external marketing consultant had “engaged in the business of effecting transactions in securities” without being properly registered as a broker or dealer or being associated with a registered broker or dealer.
• The SEC, in addition to charging the consultant for failing to register as a broker-dealer, charged the private fund manager itself with causing the consultant’s violations of the Securities Exchange Act.
• Unlike previous cases, no allegations of fraud.
43
34 Act – David Blass Speech
• In April 2013 (about a month after the Ranieri Partners case), David Blass, the Chief Counsel to the SEC’s Division of Trading and Markets, addressed a subcommittee of the American Bar Association.
• His remarks raise two separate issues: (1) whether marketing by a fund manager’s internal personnel requires broker-dealer registration and (2) whether the receipt of transaction-based fees in connection with the sale of portfolio companies requires broker-dealer registration.– Mr. Blass raised several questions, including: “How are personnel who solicit investors for a private
fund compensated? Do those individuals receive bonuses or other types of compensation that is linked to successful investors? A critical element to determining whether one is required to register as a broker-dealer is the existence of transaction-based compensation.” Broker-dealer registration “makes sense” when there is transaction-based compensation for securities sales in order to manage the conflict that arises from acting as a “securities salesman.”
– Mr. Blass separately indicated his belief that private fund managers may receive fees in addition to advisory fees that could require the adviser to register as a broker-dealer. Fees for investment banking activity, such as for negotiating transactions, finding buyers and sellers of the company’s securities or for structuring transactions were specifically mentioned. Mr. Blass noted his view that “to the extent the advisory fee is wholly reduced or offset by the amount of the transaction fee” that could be viewed as just another way to pay the advisory fee and, therefore, not raise the broker-dealer registration concern.
44
34 Act – Blackstreet Case
• The SEC has been largely silent on unregistered broker-dealer since the David Blass speech.
• SEC returned to the issue on June 1, 2016 in the Blackstreet case. The SEC found that the private equity advisory firm performed in-house brokerage services rather than using investment banks or broker-dealers to handle the acquisition and disposition of portfolio companies for a pair of private equity funds. The private equity advisory firm fully disclosed to its funds and their investors that it would provide brokerage services in exchange for a fee, yet the firm failed to comply with the registration requirements to operate as a broker-dealer.– June 1, 2016 press release, Andrew J. Ceresney, Director of the SEC Enforcement Division. stated
“The rules are clear: before a firm provides brokerage services and receives compensation in return, it must be properly registered within the regulatory framework that protects investors and informs our markets, Blackstreet clearly acted as a broker without fulfilling its registration obligations.
45
34 Act – More SEC Enforcement Actions Coming
• Shortly after Blackstreet was announced, Robert B. Baker, assistant regional director at the SEC’s Enforcement Division’s Asset-Management unit remarked at the SuperReturn U.S. conference in Boston:
– “That’s the first case of a private-equity adviser violating section 15(a) of the [Securities Exchange Act of 1934] for acting as a broker and failing to register as a broker. Advisers should be carefully considering whether their conduct violates this rule.”
46
34 Act – Broker Registration May Becoming Easier
• August 2016 SEC approved FINRA rules for Capital Acquisition Broker status– Limited Registration – May Use Projections in
Marketing– Not a full Broker-Dealer License – there are limitations
• Limited to firms that are solely corporate financing firms that advise companies on mergers and acquisitions, advise issuers on raising debt and equity capital in private placements with institutional investors, or provide advisory services on a consulting basis to companies that need assistance analyzing their strategic and financial alternatives.
• Permitted to receive Transaction-Based Compensation• New Rules being created by FINRA
47
34 Act – Limitations on CAB
• Severe Limitations on CAB brokers –disappointing rule– Limited to Institutional Investors and Qualified Purchasers
(no Accredited Investors)
– No Secondary Sales
– Associated Person of CAB cannot engage in “Private Securities Transactions” as defined by FINRA Rule 3280 (Selling Away)• For example, a PM cannot be registered with the CAB for purposes
of receiving transaction-based compensation and act as PM executing transactions for a fund.
48
Investment Advisers Act of 1940
• Imposes a fiduciary duty on advisers – understand the difference between the sale of a service and the sale of a product
• Prohibits “investment advisers” from engaging in interstate commerce in connection with his or her business as an investment adviser unless registered or exempt
• Antifraud provisions prohibit employing a device of scheme to defraud clients or operating a fraud or deceit upon a client
49
IAA Section 202(a)(11)– Definition of Investment Adviser
• An individual or a firm that, for compensation, is engaged in the business of advising others as to the value of securities or as to the advisability of investing in, purchasing, or selling securities
Definitional exceptions for private fund advisers:
– a bank, or any bank holding company generally [NB: Volcker Rule generally prohibits banks from sponsoring private funds]
• a single family office
50
IAA SEC/State Registration Jurisdictional Divide
• Under $25 million in Regulatory Assets Under Management (“RAUM”)– SEC registration prohibited (with certain limited exceptions).– Home state registration required unless exempt.– Additional state registration preempted if adviser has no place of business or
fewer than 6 resident clients, then required unless exempt.
• Between $25 and $100 million in RAUM –Mid-sized Advisers– SEC registration prohibited unless NOT required to be state registered and
examined (WY, NY) (except BDC and RIC advisers), then required unless exempt.
– State registration required unless exempt.– Additional state registration preempted if adviser has no place of business or
fewer than 6 resident clients, then required unless exempt.
• Over $100 million in RAUM– SEC registration required unless exempt.– State registration required unless exempt or SEC registered.*NB: States cannot require registration for advisers excepted from the SEC definition of investment adviser
51
IAA Common Exemptions for Private Fund Advisers
• Advisers who solely advise qualifying venture capital funds*• Foreign private advisers–limited to 15 U.S. clients/investors
and $25 million from U.S. clients• Advisers who solely advise private funds with aggregate
RAUM managed in the U.S. under $150 million*• Advisers who solely advise SBICs• Advisers who solely advise RBICs**
All definitional investment advisers are subject to anti-fraud provisions!
*Subject to exempt adviser reporting on Form ADV**Added by The RBIC Advisers Relief Act of 2018, Pub. L. No. 115-417, 132 Stat. 5438 (Jan. 3, 2019)
52
IAA Section 203(b)(3)—Foreign Private Adviser Exemption
• Any investment adviser who:– has no place of business in the U.S.; – has, in total, fewer than 15 clients and investors in the U.S. in private
funds advised by the investment adviser; – has aggregate assets under management attributable to clients in the
U.S. and investors in the United States in private funds advised by the investment adviser of less than $25 million, or such higher amount as the SEC may, by rule, deem appropriate; and
– neither—• holds itself out generally to the public in the U.S. as an investment adviser; • nor advises any ICA registered investment company; or a company that has
elected to be a business development company, and has not withdrawn its election.
• Self-executing, no reporting required• BUT, there is another limited reporting regime for foreign exempt
reporting advisers.
53
IAA Rule 203(m)-1—Private Fund Adviser Exemption
• U.S. advisers--An investment adviser with its principal office and place of business in the U.S. is exempt from registration if it: – Acts solely as an investment adviser to one or more qualifying private funds;
and – Manages private fund assets of less than $150 million.*
• Non-U.S. advisers--an investment adviser with its principal office and place of business outside of the U.S. is exempt from registration if it: – Has no client that is a U.S. person except for one or more qualifying private
funds; and – All assets managed by the investment adviser at a place of business in the U.S.
are solely attributable to private fund assets, the total value of which is less than $150 million.
• The Commission shall require such advisers to maintain such records and provide to the Commission such annual or other reports as the Commission determines necessary or appropriate in the public interest or for the protection of investors.
*Exclusive of RBIC assets.
54
IAA Rule 203(m)-1—Qualifying Private Funds
• Any private fund that is not registered under the ICA and has not elected to be treated as a business development company.
• An issuer that qualifies for an exclusion from the definition of an “investment company,” as defined in ICA Section 3, in addition to those provided by section ICA Sections 3(c)(1) or 3(c)(7), provided that the adviser treats the issuer as a private fund under the Act and the rules thereunder for all purposes. Useful in the syndication/SPV space.
55
IAA Section 203(l)--Exemption of Venture Capital Fund Advisers
• No investment adviser that acts as an investment adviser solely to 1 or more venture capital funds shall be subject to the registration requirements of this subchapter with respect to the provision of investment advice relating to a venture capital fund.
• The Commission shall require such advisers to maintain such records and provide to the Commission such annual or other reports as the Commission determines necessary or appropriate in the public interest or for the protection of investors.
56
IAA Section 203(l)-- Venture Capital Funds Defined
Any private fund that:
• Represents to investors and potential investors that it pursues a venture capital strategy;
• Immediately after the acquisition of any asset, other than “qualifying investments” or short-term holdings, holds no more than 20% of the amount of the fund's aggregate capital contributions and uncalled committed capital in assets (other than short-term holdings) that are not qualifying investments, valued at cost or fair value, consistently applied by the fund;
• Does not borrow, issue debt obligations, provide guarantees or otherwise incur leverage, in excess of 15% of the private fund's aggregate capital contributions and uncalled committed capital, and any such borrowing, indebtedness, guarantee or leverage is for a non-renewable term of no longer than 120 calendar days, except that any guarantee by the private fund of a qualifying portfolio company's obligations up to the amount of the value of the private fund's investment in the qualifying portfolio company is not subject to the 120 calendar day limit;
• Only issues securities the terms of which do not provide a holder with any right, except in extraordinary circumstances, to withdraw, redeem or require the repurchase of such securities but may entitle holders to receive distributions made to all holders pro rata; and
• Is not registered under the ICA and has not elected to be treated as a business development company.
• Is a Rural Business Investment Company.*
*Added by The RBIC Advisers Relief Act of 2018, Pub. L. No. 115-417, 132 Stat. 5438 (Jan. 3, 2019)
57
IAA Section 203(b)(7)--SBIC Fund Adviser Exemption
• Any investment adviser, other than any entity that has elected to be regulated or is regulated as a business development company pursuant to ICA Section 54, who solely advises—– (A) small business investment companies that are licensees under the
Small Business Investment Act of 1958; – (B) entities that have received from the Small Business Administration
notice to proceed to qualify for a license as a small business investment company under the Small Business Investment Act of 1958, which notice or license has not been revoked; or
– (C) applicants that are affiliated with 1 or more licensed small business investment companies described in subparagraph (A) and that have applied for another license under the Small Business Investment Act of 1958, which application remains pending.
• Self executing, no reporting required
58
SBIC Advisers Relief Act of 2015
• Adopted as part of H.R. 22, the Fixing America's Surface Transportation Act of 2015—the FAST Act
– Amends Section 203(m) of the Advisers Act to exclude from the Private Fund Adviser Exemption $150,000,000 asset limit, the assets of a private fund that is an SBIC fund (other than a BDC)
– Amends Advisers Act Section 203A(b)(1) to preempt states from requiring advisers relying on the SBIC fund exemption to register, license or qualify as an investment adviser in the state
59
The RBIC Advisers Relief Act of 2018
• Provids one new and two expanded exemptions from registration for investment advisers who advise rural business investment companies (RBICs)
– New section 203(b)(8) exempts from registration any investment adviser who solely advises RBICs [no reporting, recordkeeping or exams]
– Expands the definition of venture capital fund to include RBICs
– Excludes RBIC assets from counting toward Private Fund Adviser Exemption $150M AUM threshold
• Also preempts states from requiring advisers relying on the SBIC fund exemption to register, license or qualify as an investment adviser in the state
60
IAA Exempt Reporting Adviser Compliance
• Section 204’s required reporting on Form ADV and certain recordkeeping requirements [NB: possible SEC exams]
• Section 204A’s requirement to implement written policies and procedures reasonably designed to prevent the misuse of material non-public information (MNPI).
• Sections 206 and 207’s anti-fraud provisions (including restrictions on principal transactions), as well as Rule 206(4)-8’s anti-fraud provisions for advisers to pool investment vehicles
• Rule 206(4)-6’s pay to play restrictions for political contributions by advisers [NB: this applies to foreign private advisers as well]
[NB: Form PF is required only for SEC RIA to private funds.]
61
IAA Section 205—Compensation Prohibition
• No investment adviser registered or required to be registered with the Commission shall enter into ...any investment advisory contract…, if such contract provides for compensation to the investment adviser on the basis of a share of capital gains upon or capital appreciation of the funds or any portion of the funds of the client
• Prohibition does not apply if the client entering into the contract is a qualified client– each equity owner of a 3(c)(1) fund (except for the investment
adviser entering into the contract and any other equity owners not charged a fee on the basis of a share of capital gains or capital appreciation) will be considered a client for this purpose
• Prohibition does not apply if the client entering into the contract is a 3(c)(7) funds
62
IAA Rule 205-3--“Qualified Clients” Defined
• A natural person who, or a company that, immediately after entering into the contract has at least $1 million under the management of the investment adviser;
• A natural person who, or a company that, the investment adviser entering into the contract (and any person acting on his behalf) reasonably believes, immediately prior to entering into the contract, either: – Has a net worth (together, in the case of a natural person, with assets held jointly with a
spouse) of more than $2 ,100,000;* or– Is a qualified purchaser at the time the contract is entered into; or
• A natural person who immediately prior to entering into the contract is: – An executive officer, director, trustee, general partner, or person serving in a similar capacity,
of the investment adviser; or – An employee of the investment adviser (other than an employee performing solely clerical,
secretarial or administrative functions with regard to the investment adviser) who, in connection with his or her regular functions or duties, participates in the investment activities of such investment adviser, provided that such employee has been performing such functions and duties for or on behalf of the investment adviser, or substantially similar functions or duties for or on behalf of another company for at least 12 months.
* Section 418 of the Dodd-Frank Act, which requires the SEC to issue an order every five years to adjust for inflation. Effective as of August 15, 2016, the dollar amount of the net worth test increased from $2,000,000 to $2,100,000. The dollar amount of the assets-under-management test will remain $1,000,000 because the amount of the SEC’s inflation adjustment calculation is smaller than the rounding amount required by the rule.
63
Thank You
Genna Garver
Partner
Direct: (212) 704-6045
────────────
troutman sanders
875 Third Avenue
New York, NY 10022
troutman.com
64
Gregory J. Nowak
Partner
3000 Two Logan Square | Eighteenth and Arch StreetsPhiladelphia, Pennsylvania 19103-2799and
The New York Times Building | 37th Floor | 620 Eighth AvenueNew York, New York 10018-1405p: 215.981.4893 or 212.808.2700 | f: 215.689.4505 | m: 215.421.7288 |
