Purchasers and Qualified Clients Evaluating Exemptions for Funds and - - PowerPoint PPT Presentation

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Presenting a live 90-minute webinar with interactive Q&A

Private Fund Securities Law Exemptions: Navigating Accredited Investors, Qualified Purchasers and Qualified Clients

Evaluating Exemptions for Funds and Managers Under the Investment Adviser, Securities, Exchange and Investment Company Acts

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific TUESDAY, SEPTEMBER 13, 2016

Daniel M. Baich, Of Counsel, Dorsey & Whitney, New York Genna Garver, Of Counsel, Dorsey & Whitney, New York

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Private Fund Securities Law Exemptions: Navigating Accredited Investors, Qualified Purchasers and Qualified Client

Genna Garver and Daniel Baich

Private Fund Securities Laws

• Securities Act of 1933
• Investment Company Act of 1940
• Securities Exchange Act of 1940
• 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.

33 Act – Common Exemptions

• Section 4(a)(2)
• Regulation D Safe Harbor
• Regulation S Safe Harbor

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

• f 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

• ffering 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

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

• ne 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
• f $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 Modifications to Definition

• Accredited Investors

– December 18, 2015 – SEC Report on The Review of the Definition of Accredited Investor - 2 Main Recommendations

• 1. Revise the current financial thresholds for natural persons.
• 2. Allow for other forms of proof of investor sophistication.
• SEC staff did not recommend the elimination of the

accredited investor definition, but rather recommended modifications to the existing standards.

15

33 Act – Accredited Investors – Proposed Modifications to Definition

• Revise the current financial thresholds for natural persons.

– Leave the current income and net worth thresholds in place, subject to investment limitations. – Create additional inflation-adjusted income and net worth thresholds that are not subject to investment limitations. – Index all financial thresholds for inflation on a going-forward basis. – Permit spousal equivalents to pool their finances for purposes of qualifying as accredited investors. – Revise the definition as it applies to entities by replacing the $5 million assets test with a $5 million investments test and including all entities rather than specifically enumerated types of entities. – Grandfather issuers’ existing investors that are accredited investors under the current definition with respect to future offerings of their securities.

16

33 Act – Accredited Investors – Proposed Modifications to Definition

• Allow individuals to qualify as accredited investors

based on other measures of sophistication.

– Permit individuals with a minimum amount of investments to qualify as accredited investors. – Permit individuals with certain professional credentials to qualify as accredited investors. – Permit individuals with experience investing in exempt

• fferings to qualify as accredited investors.

– Permit knowledgeable employees of private funds to qualify as accredited investors for investments in their employer’s funds. – Permit individuals who pass an accredited investor examination to qualify as accredited investors.

17

33 Act – Accredited Investors – Proposed Modifications to Definition

• Accredited Investors Definition

– Many of the proposals have been discussed for years, without any formal rule proposals. – SEC staff hinted that if the current definition of accredited investor is not revised, it should be coupled with a minimum investment amount or a limit on how much of a person’s net worth may be invested within a 12-month period.

18

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

• ccurred 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)

19

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

• ffering

– 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

20

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.

21

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

• nly, in which the market will let investors dictate the

type of information that they need in order to make informed investment decisions

22

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

• ffer 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

23

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.

24

33 Act – Regulation S

• Regulation S Safe Harbor

– Regulation S provides an exclusion from registration for offerings made

• utside 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

25

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.

26

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.

27

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

– 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 it it’s 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 offshore fund has no more than 100 beneficial owners resident in the U.S.

28

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)

29

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

• r 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 – 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.

30

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
• perations 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

31

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?

32

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 it it’s 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.

33

ICA Section 2(a)(51) –Definition of “Qualified Purchaser”

• Statutory definition:

– (i) any natural person (including any person together with their spouse) who

• wns 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

• ther 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.

34

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.

35

“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
• wn 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

• wner 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 trust that is not a qualified purchaser under Section 2(a)(51)(A)(iii) is because its settlor and/or trustee is not a qualified purchaser even if all of the trust’s beneficiaries are qualified purchasers

• 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

36

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 from Issuers at certain

thresholds and Broker-Dealers

37

34 Act – Issuer Registration

• Section 12(g) establishes the thresholds at

which an issuer is required to register a class

• f securities with the SEC.
• Thresholds for Registration

– Total assets exceeding $10M; – 2,000+ investors or 500 unaccredited investors

38

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

• r 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 sales of securities by Officers, Employees and other Associated Persons of the Issuer

39

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

40

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

41

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.

42

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

43

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

44

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.

45

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.

• Hiss remarks raise two separate issues: (1) whether marketing by a fund manager’s

internal personnel requires broker-dealer registration and (2) whether the receipt

• f 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.

46

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

• ur markets, Blackstreet clearly acted as a broker without fulfilling its registration obligations.

47

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

• f 1934] for acting as a broker and failing to register as

a broker. Advisers should be carefully considering whether their conduct violates this rule.”

48

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

• 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

49

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
• f receiving transaction-based compensation and act as PM

executing transactions for a fund.

50

Investment Advisers Act of 1940

• Implicit fiduciary duty
• Prohibits “investment advisers” from engaging

in interstate commerce in connection with his

• r her business as an investment adviser

unless registered or exempt

• Antifraud provisions prohibit employing a

device of scheme to defraud clients or

• perating a fraud or deceit upon a client

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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 family office--everyone wants to be George Soros

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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

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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 [NB: newly amended Section

203A(b)(1) preempts states from requiring SBIC Fund advisers to register as if they were excepted from the SEC definition of investment adviser] All definitional investment advisers are subject to anti-fraud provisions!

*Subject to exempt adviser reporting on Form ADV

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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 advisers 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

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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
• f 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.

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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. [NB: this includes for purposes of Form PF]

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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.

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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
• f 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.

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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

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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 a 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

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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

• f material non-public information (MNPI).
• Sections 206 and 207’s anti-fraud provisions (including

restrictions on principal transactions), as well as Rule 206(4)-7’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.]

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IAA Compliance Requirements for SEC Registered Investment Advisers

• Report on full Form ADV, Parts 1 and 2
• Designate Chief Compliance Officer
• Develop, implement and review written policies and procedures tailored to the

adviser’s business addressing (at a minimum):

– Portfolio management and trading practices, proprietary and insider trading, client disclosures, custody, performance-based fees, proxy voting, solicitation arrangements, advertising, pay-to-play and business continuity plans.

• Adopt and enforce a Written Code of Ethics
• Annual compliance review
• Maintain all required books and records—SEC’s special and periodic exam authority
• Maintain “custody” assets with a qualified custodian
• Comply with the restrictions on advisory contracts, including limiting performance-

based compensation to “qualified clients”*

• Comply with restrictions for cash payments for client solicitations
• Proposed business continuity and transition planning

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IAA Private Fund Umbrella Registration

• Method of filing a single umbrella registration as

established in a 2012 SEC staff no-action letter

– Multiple private fund advisers under common control with the filing adviser – Conducting a single advisory business – Each must individually have sufficient RAUM to qualify for SEC registration or qualify for an exemption from Advisers Act section 203A’s prohibition – Must satisfy other conditions set forth in letter (see next slide) NB: Does not apply to ERAs, by certain ERAs are permitted to file a single Form ADV on behalf of multiple SPVs

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IAA Fund Umbrella Registration— Conditions

• (i) the filing adviser and each relying adviser advise only private funds and clients

in separately managed accounts that are qualified clients (as defined in rule 205-3 under the Advisers Act) and are otherwise eligible to invest in the private funds advised by the filing adviser or a relying adviser and whose accounts pursue investment objectives and strategies that are substantially similar or otherwise related to those private funds;

• (ii) the filing adviser has its principal office and place of business in the U.S.;
• (iii) each relying adviser, its employees and the persons acting on its behalf are

subject to the filing adviser’s supervision and control and, therefore, each relying adviser, its employees and the persons acting on its behalf are “persons associated with” the filing adviser (as defined in section 202(a)(17) of the Advisers Act);

• (iv) the advisory activities of each relying adviser are subject to the Advisers Act

and the rules thereunder, and each relying adviser is subject to examination by the SEC;

• (v) the filing adviser and each relying adviser operate under a single code of ethics

adopted in accordance with rule 204A-1 under the Advisers Act and a single set of written policies and procedures adopted and implemented in accordance with rule 206(4)-(7) under the Advisers Act and administered by a single CCO in accordance with that rule.

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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

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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,

• f 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

• f 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.

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Thank You

Genna Garver Dorsey & Whitney LLP garver.genna@dorsey.com Daniel Baich Dorsey & Whitney LLP baich.daniel@dorsey.com

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