Monthly Archives: September 2012

JOBS ACT – SEC Proposes New Changes to Rules 506 and 144A

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The JOBS Act, enacted earlier this year, directed the SEC to remove prohibitions on general solicitation and general advertising and revise rules on the resale of securities by large institutional investors. On August 29th, the SEC issued a proposed rule to modify Rules 506 and 144A of the Securities Act, which deal with general solicitation and advertising and resales of securities by large institutional investors, respectively.

Rule 506

Under the proposed rule, companies issuing securities would be permitted to use general solicitation and general advertising to offer securities if the following conditions have been met:

  • The issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors.
  • All purchasers of securities are accredited investors, because either:
    • They come within one of the categories of persons who are accredited investors under existing Rule 501.
    • The issuer reasonable believes that the meet one of the categories at the time of the sale of the securities.

The proposed rule would use a set of factors to determine if an issuer has taken the necessary steps to verify a purchaser is an accredited investor. These factors include:

  • The issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors.
  • The amount and type of information that the issuer has about the purchaser.
  • The nature of the offering, meaning:
    • The manner in which the purchaser was solicited to participate in the offering.
    • The terms of the offering, such as a minimum investment amount.

Form D

The proposed rule would also affect Form D, which issuers must file with the SEC when they sell securities under Regulation D. The revised form would contain a new separate box for issuers to check if they are claiming the new Rule 506 exemption that would permit general solicitation and general advertising.

Rule 144A and QIBs

The Rule 144A exemption is a safe harbor under Section 5 of the Securities Act of 1933 that essentially allows unlimited resales of certain unregistered securities of US and foreign issuers not listed on a US securities exchange or quoted on a US automated inter-dealer quotation system to “qualifying institutional buyers” (QIBs). A QIB is an entity acting for its own account or the accounts of other qualified institutional buyers that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entity. For hedge funds and private funds this means an unregistered fund or entity that owns or invests at least $100 million in securities of unaffiliated issuers and a registered fund manager acting for its own account or the accounts of other QIBs that in the aggregate owns and has discretions over at least $100 million in securities of unaffiliated issuers. Even if a manager is a QIB, each fund itself must have $100 million in securities to qualify as a QIB.

Under the proposed rule, offers of securities could be made to investors who are not QIBs as long as the securities are sold only to persons whom the seller and any person acting on behalf of the seller reasonably believe are QIBs.

Conclusion

The modification of Rule 506 would allow companies to advertise and solicit the sales of securities in ways that they had not been able to do so previously. The effect on Rule 144A would be to permit the offers of securities to investors who are not QIBs but persons whom the seller reasonably believes are QIBs.

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Cole-Frieman Mallon & Hunt LLP, an investment management law firm which provides legal services to the hedge fund industry. Bart Mallon can be reached directly at 415-868-5345.

 

FATCA Implications for Hedge Funds

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Foreign Account Tax Compliance Act Overview

The Foreign Account Tax Compliance Act (“FATCA”) was enacted by Congress as part of the HIRE Act of 2010. FATCA will become effective on January 1, 2013 and some parts of the act will be applicable to investment managers. The primary objective behind FATCA is to combat tax evasion by making it difficult for U.S. persons to hide income and assets overseas. To accomplish this objective, the new regulations will require financial institutions to identify and disclose direct and indirect U.S. investors and withhold U.S. income tax on nonresident aliens and foreign corporations. Foreign financial institutions, and certain onshore entities, will be required to comply with the new disclosure and tax withholding requirements or be subject to a 30% FATCA tax. While proposed regulations and applicable forms have yet to be finalized, investment managers should be prepared for the new FATCA regime and compliance rules.

Application to Investment Funds

Non-U.S. Funds

Foreign financial institutions (each, an “FFI”), which include hedge funds, funds of funds, commodity pools and other offshore investment vehicles, will be required to enter into an agreement with the IRS (“FFI Agreement”) to avoid being subject to the FATCA tax. Each FFI will be required to:

  • obtain, verify and report information on its direct and indirect U.S. investors pursuant to specific due diligence procedures;
  • perform annual reporting;
  • deduct and withhold 30% from any payment made by the fund to U.S. investors refusing disclosure and non U.S. investors without proper FATCA documentation; and
  • comply with requests for additional information.

U.S. Funds

Domestic funds will need to determine the FATCA status of each of their investors and will be subject to new due diligence and reporting obligations for current and new investors. In addition, U.S. funds will be required to deduct and withhold a 30% FATCA tax from investors who do not provide the required documentation.

FATCA Timeline

The current timeline for FATCA compliance is as follows (however dates may change as regulations are finalized):

  • FFI Agreement – FFIs will be able to enter into an FFI Agreement through an IRS online system starting on January 1, 2013 (but no later than June 30, 2013).
  • Reporting Obligations – due diligence and reporting requirements under FATCA will be implemented in a staggered manner, based on an investor’s account balance, beginning on January 1, 2013. IRS plans to release new tax forms in the next few months.
  • Withholding Obligations – the 30% FATCA tax will be implemented in a staggered manner, beginning on January 1, 2014 and will eventually include interest, dividends and other FDAP (fixed, determinable, annual, periodic) income from U.S. sources, gross proceeds from sale of U.S. securities and foreign pass-through payments.

Next Steps

As we mentioned previously, final regulations have not been promulgated. However, when they are, managers will need to do the following:

  1. Review and update fund offering documents and other investor agreements to disclose additional reporting obligations imposed by FATCA and risk of withholding for “recalcitrant investors” (those investors who choose not to disclose their name to the IRS).
  2. Asses fund structure and identify entities that may be affected by new FATCA regime.
  3. Work with third-party service providers to ensure proper registration and compliance once FATCA rules are finalized, including: (a) investor due diligence and documentation; (b) FFI Agreement; and (c) FATCA withholding.

If you have questions about the new FATCA requirements and how they impact your fund, please contact us directly.

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Cole-Frieman & Mallon LLP, an investment management law firm which provides legal services to the hedge fund industry. Bart Mallon can be reached directly at 415-868-5345.

California Private Fund Adviser Exemption Approved

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California Hedge Fund Managers Relieved of IA Registration Requirement

On August 27, 2012 (“Effective Date”), the California Office of Administrative Law approved the long awaited private fund adviser exemption (“Private Fund Exemption”). The immediately effective exemption is only available to advisers who provide advice solely to “qualifying private funds,” which include venture capital funds, Section 3(c)(1), and Section 3(c)(7) funds. The Private Fund Exemption is not available to advisers who also manage separate accounts.

Currently, a California based adviser who manages less than $100,000,000 must either register as an investment adviser with the California Department of Corporations (“Department”), or rely on an exemption from registration. Under the new Private Fund Exemption advisers can file as “exempt reporting advisers” (“ERAs”) and thereby avoid the burdensome registration process.

Requirements Generally

To qualify for the Private Fund Exemption, the adviser must

  1. have not violated any securities laws;
  2. file and periodically update certain items on Part 1 of the Form ADV;
  3. pay California’s investment adviser registration and renewal fees; and
  4. fulfill any additional requirements when advising funds organized under Section 3(c)(1).

Additional Requirements for 3(c)(1) Fund Managers

The additional requirements for advisers advising 3(c)(1) funds include:

1. All investors in the fund must either (i) be accredited investors; (ii) be managers, directors, officers or employees of the adviser; or (ii) have received the fund interest via a transfer not involving a sale.

2. Advisers may only charge performance fees to qualified clients; and

3. Advisers shall provide each investor with annual audited financial statement of the fund within 120 days after the end of each fiscal year; provided, however, advisers who begin operations more than 180 days into a fiscal year may include the audit of the initial fiscal year in the fiscal year immediately succeeding the initial fiscal year.

Other Information

An adviser to 3(c)(1) funds that existed prior to Effective Date may take advantage of the Private Adviser Exemption if, as of the Effective Date, it complies with the requirements enumerated above. Any investors in funds existing prior to the Effective Date who do not meet the standards outlined in Item 1 above, will be allowed to remain in the funds provided that they do not make any additional capital contributions. Furthermore, as of the Effective Date, advisers must cease charging performance fees to any investors who do not meet the “qualified client” definition.

To take advantage of the Private Fund Exemption, an adviser must file a partial Form ADV with the Department via the IARD system no later than 60 days from the Effective Date. Advisers currently registered with the Department may choose to withdraw their registration and make a filing under the Private Fund Exemption.

For information on whether your firm may be able to claim an exemption from registration, please see the California Private Fund Adviser Exemption Chart.

If you would like help to utilize the California exemption, please contact us directly.

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Bart Mallon is a partner with Cole-Frieman Mallon & Hunt LLP, an investment management law firm which provides legal services to the hedge fund industry. Bart can be reached directly at 415-868-5345.

Hedge Fund Events September 2012

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The following are various hedge fund events happening this month. Please contact us if you would like us to add your event to this list.

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September 6

September 9-11

September 12-14

September 13

September 13

September 13

September 13

September 19

September 19

September 19

September 20

September 20

September 20

September 20

September 25

September 27

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Cole-Frieman Mallon & Hunt LLP provides legal services for hedge fund managers and other groups within the investment management industry. Bart Mallon can be reached directly at 415-868-5345.