Iowa has a very good securities division which is familiar with the rules regarding hedge fund private placements. The notice below was provided by Iowa’s securities division to inform entities engaging in private placements the specific rules applicable to Iowa. Notice like this is invaluable to start up hedge funds as it will help the manager to know what exactly the rules are in Iowa. As we’ve noted in other articles (Overview of Regulation D for Hedge Funds), each state will have different rules regarding Rule 506 offerings which most all hedge funds utilize. Of great importance for hedge fund managers, the letter below discusses how non-accredited investors should be treated for the purpose of Iowa.
Please let us know if you have any questions. Other related start up hedge fund articles include:
- Starting a Hedge Fund
- Start up Hedge Fund Managers – Recommended Articles
- Start Up Hedge Fund Timeline
- Hedge Fund Performance Fee Issues for State Registered Investment Advisors
- Hedge Fund Lawyer
- Hedge Fund Offering Documents
- Securities Act of 1933
The following release can be found here.
RE: Private Placement Exemption 502.202(14) – Federal Regulation D Rule 504/ Section 4(2)/Federal Regulation D Rule 505
Federally Covered Securities 502.302(3) – Federal Regulation D Rule 506
The purpose of this letter is to respond to your inquiry concerning the private placement exemption pursuant to Iowa Code Chapter 502.202(14) and/or the Federal Covered Securities notice filing for Regulation D Rule 506 offerings pursuant to Iowa Code Chapter 502.302(3). The applicable Iowa Administrative Code (“IAC”) Rules (IAC Rule 191-50.80, IAC Rule 191-50.81 and IAC Rule 191-50.88) are referenced in this letter and detail the filing requirements, if any.
THE PRIVATE PLACEMENT EXEMPTION
THE BASIC REQUIREMENTS AND FEATURES OF § 502.202(14) ARE AS FOLLOWS:
1. An issuer may not sell its unregistered securities, as part of a single issue, to more than thirty-five (35) purchasers in this state during any twelve (12) consecutive month period. The total number of security holders may ultimately exceed thirty-five (35) so long as the issuer does not sell to more than thirty-five (35) purchasers in this state during any twelve (12) consecutive month period. For example, if “XYZ Company” were to sell its unregistered securities to twenty-five (25) purchasers in this state today and if it were to sell to an additional ten (10) purchasers in this state tomorrow, then it may legally sell its unregistered securities to an additional twenty-five (25) purchasers in this state a year from today and to an additional ten (10) purchasers in this state a year from tomorrow pursuant to the private placement exemption. The 35 purchaser limitation is a “moving target” using a consecutive twelve month period as a parameter.
A purchaser in this state, who purchases an issuer’s private placement securities on multiple
occasions, may be counted as an additional purchaser when each sale occurs.
If a private placement purchaser in this state is a legal entity, such as a trust, partnership or corporation, it is probable that every respective beneficiary, partner and shareholder, thereof, will be counted as separate, additional purchasers if the legal entity was organized for the specific purpose of acquiring the securities being offered.
The Administrator has taken the position that a husband and wife will be counted as one purchaser in this state, even though they may have purchased an issuer’s private placement securities separately.
2. Iowa Code Section § 502.202(13) grants an “exempt transaction” status to an issuer’s sale of securities when they are sold to banks, savings institutions, trust companies, insurance companies, investment companies as defined under the Investment Company Act of 1940, pension or profit sharing trusts, financial institutions, institutional buyers or broker-dealers, so long as the purchaser is acting for itself or in a fiduciary capacity.
The aforesaid § 502.202(13) transactional exemption will exempt entities, including certain “specified investors”, who purchase an issuer’s private placement securities for their own account for investment. “Specified investors” include “accredited investors” and are defined under IAC Rule 191-50.88. Further, please note that such specified investors are not counted towards the thirty-five (35) purchaser limitation imposed under § 502.202(14). Iowa Administrative Rule (IAC) 191-50.88 defines transactions with specified investors as follows:
50.88(1) Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer.
50.88(2) Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of the purchase exceeds $1 million.
50.88(3) 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 in each of those years and has a reasonable expectation of reaching the same income level in the current year.
50.88(4) Any venture or seed capital company. For purposes of this subrule, a venture or seed capital corporation is a corporation, partnership or association that’s been in existence for at least five years, or whose net assets exceed $250,000, and whose primary business is investing in developmental stage companies or “eligible small business companies” as that term is defined in the regulations of the Small Business Administration.
This rule is intended to implement Iowa Code section 502.202(13).
3. The sale of an issuer’s exempt securities must be part of a single issue. The phrase, “part of a single issue,” refers to a securities concept known as the “integration” of securities offerings. The following factors are relevant when considering the “single issue” or “integration” question:
a. Are the offerings part of a single plan of financing?
b. Do the offerings involve the issuance of the same class or type of securities?
c. Were the offerings made at, or about, the same time?
d. Was the same type of consideration received?
e. Were the offerings made for the same general purpose?
When two or more securities offerings meet one or more of the integration standards, they may be considered part of a single issue. If so, the securities offerings are deemed to be part of the same securities offering. Therefore, if two or more offerings by an issuer are deemed to be part of a single issue, then all of the purchasers in the offerings, except institutional buyers, will be counted towards the (thirty-five (35) purchasers in this state during any twelve (12) consecutive month period) limitation.
4. The issuer must reasonably believe that all purchasers in this state are purchasing the securities with investment intent and not with intent to resell. Resale of private placement securities may occur if the security holder has met the investment intent requirement. For example, if a resale of private placement securities is made pursuant to a bona fide unforeseen change of circumstances, or if the securities have been held for a sufficient length of time to evidence the fact that the original purchase was for investment rather than for resale, then it may be presumed that the investment intent requirement of the statute has been met. A twelve (12) month, or longer, holding period is usually deemed to be a “safeharbor” in determining investment intent. All resale of private placement securities must be pursuant to an available exemption or the securities must be registered.
Issuers, who use the § 502.202(14) exemption, are urged to obtain a letter evidencing investment intent from each purchaser in this state. This cautionary step should also be taken in with institutional buyers, even though they are not counted towards the thirty-five (35) purchaser limitation.
5. No commissions or other remuneration may be paid or given, directly or indirectly, for or on account of the private placement sale of securities unless they are permitted by rule or by an administrative order. The “commissions or other remuneration” language is interpreted broadly and includes, but is not limited to, sales commissions, finders’ fees, discounts, options or warrants, some management fees, and acquisition fees.
6. If the private placement exemption is available, it may be otherwise self-executing in that the issuer will not be required to file any documents or fees with the Bureau. A filing will be required when commissions (or other remuneration) are paid. A post sale filing for Rule 506 Regulation D will be required if the issuer chooses this federally covered exemption. In this situation, please refer to IAC 191-50.81 for the filing requirements.
7. The Bureau requires that written information concerning the issuer be made available to all prospective purchasers prior to their purchase. This information should be in the form of a disclosure document similar to a prospectus. Failure to provide the investor with material information sufficient to make an informed investment may result in violation of anti-fraud and civil liability provisions of the Act. Disclosure must include a discussion of risk factors and current financial statements. A private placement memorandum should disclose the types of information set forth under Iowa Code section 502.304, if applicable. In addition, the Bureau provides a disclosure format, referred to as Form U-7, and an Issuer’s manual that discusses content to be included in the Form U-7, on its website. The Form U-7 is designed to provide the type of information an investor would normally need in order to make an informed investment decision. The Bureau suggests Issuers consider using Form U-7 with private offering of securities in order to insure adequate information is provided to the investor.
8. The issuer and/or broker-dealer must refrain from any form of general solicitation or advertising. The prohibition relating to general solicitation or advertising, is interpreted broadly. In addition to what is normally viewed as public advertising, this may also include mass mailings, feature stories on the issuer by the news media, meetings that are held for the purpose of soliciting potential purchasers, etc.
9. Issuers who intend to make private placement securities sales to purchasers outside of this state, should check with the respective state securities regulatory agency where the offers and sales are to occur, as well as with the Securities and Exchange Commission, in order to comply with the applicable securities laws and regulations.
10. The issuers and broker-dealers associated with the private placement exemption remain subject to the anti-fraud and civil liability provisions of Iowa Code §§ 502.501 et seq.
11. In conjunction with § 230.505 of Regulation D of the Securities Act of 1933, Iowa has adopted Iowa Administrative Rule 191-50.80. The basic requirements and provisions of Rule 191-50.80 are as follows:
a. A securities transaction is exempt from the registration provisions of the Iowa Uniform Securities Act if the securities are offered or sold in compliance with § 230.505 of Regulation D of the Securities Act of 1933. This securities transaction exemption also applies to any offer or sale of securities that is made exempt by the application of § 230.508(a) of Regulation D, as made effective in Release No. 33-6389, as amended by Release Nos. 33-6437, 33-6663, 33-6758, and 33-6825.
b. The issuer must file a notice on Form D (17 CFR 239.500) with the Administrator within fifteen (15) days following the date of the first ULOE sale in Iowa. The notice must be accompanied by:
a. A copy of any written information that has been, or is to be, furnished to investors;
b. A consent to service of process on Form U-2; and
c. A filing fee of one hundred ($100.00) dollars. Checks should be made out to the
Iowa Securities and Regulated Industries Bureau.
c. Code § 230.505 of Regulation D permits sales to a total of thirty-five (35) non-accredited investors and an unlimited number of accredited investors, as defined by § 230.501(a) of Regulation D. The aggregate offering price of the limited offering made pursuant to § 230.505 of Regulation D shall not exceed five million ($5,000,000) dollars during any twelve (12) consecutive month period.
d. The issuer, or any person who acts on its behalf, when making sales to non-accredited investors, must reasonably believe that either:
1. The investment is suitable for the purchaser (if the investment does not exceed ten (10%) percent of the investor’s net worth, it is presumed to be suitable); or
2. The purchaser has sufficient knowledge and experience in financial and business matters to make a capable evaluation of the prospective investment’s risks and merits.
e. Neither the issuer, nor any person who acts on its behalf, may offer or sell the securities through any form of general solicitation or advertising.
f. Rule 50.80(2)”a”(1) prohibits the payment of commissions or other remuneration for the sale of Regulation D Rule 505 securities to any Iowa purchaser, unless the salesperson is registered pursuant to Iowa Code § 502.401.
g. The exemption is not available to an issuer if any of the parties described in § 230.252(c), (d), (e), or (f), Regulation A, Securities Act of 1933:
1. Has filed a registration statement that is subject to a currently effective stop order entered pursuant to any state’s securities law within five (5) years prior to the ULOE notice filing;
2. Has been convicted, within the last five (5) years, of any felony or misdemeanor in connection with the offer, purchase or sale of any security or any felony involving fraud or deceit;
3. Is currently subject to any state administrative enforcement order or judgment entered by that state’s securities administrator within the last five (5) years;
4. Is subject to any state’s administrative enforcement order or judgment that prohibits, denies or revokes the use of any exemption from securities registration; or
5. Is currently subject to any order, judgment, or decree, of any court of competent jurisdiction, that restrains or enjoins the party from engaging in any conduct or practice in connection with the purchase or sale of securities or from making any false filing with the state entered within five (5) years of the required notice filing.
FEDERAL COVERED SECURITY
To coordinate with requirements set forth in Securities Improvement Act, the Iowa Securities Bureau has adopted a notice filing procedures for § 230.506 of Regulation D of the Securities Act of 1933 (“Reg D”).
The basic requirements and provisions of Rule 191-50.81 (IAC) are as follows:
1. An issuer offering a security that is a covered security under Section 18(b)(4)(D) of the Securities Act of 1933 shall file a notice on SEC Form D, including the Appendix, a consent to service of process on a form U-2 as prescribed by rule 50.51(502), and pay a fee of $100 to the Iowa Securities Bureau no later than 15 days after the first sale of the federally covered security in this state. If the sale occurred beyond 15 days, a late filing fee
2. For purposes of this rule, the Securities and Exchange Commission’s “Form D” is defined as the document, as adopted by the Securities and Exchange Commission and in effect on September 1, 1996, and as may be further amended by the Securities and Exchange Commission from that time, entitled “FORM D: Notice of Sale of Securities pursuant to Regulation D, Section 4(6), and/or Uniform Limited Offering Exemption.” The filing of this form with the state of Iowa shall include Part E (the state signature page) and the Appendix.
Nothing in Rule 191-50.80, Rule 191-50.81 and Rule 191-50.88, or in the exemptions pursuant to § 502.202(13) and 502.202(14), shall relieve anyone from providing sufficient disclosure to prospective investor adequate to satisfy civil liability and anti-fraud provisions of Iowa Code Section 502.501 Nothing in the aforesaid exemptions relieves anyone from due diligence, suitability or “know your customer” standards.
In view of the objectives of § 502.202(13), § 502.202(14), Rule 191-50.80, Rule 191-50.81 ,Rule
191-50.88 and the purposes and policies underlying Iowa Code Chapter 502, these exemptions are not available to any issuer with respect to any transaction that is part of a plan or scheme to evade the registration provisions or the conditions and limitations explicitly stated in Iowa Code Chapter 502 and the Iowa Administrative Rules pertaining thereto.
This letter is only a summary. Reference should be made to Iowa Code Chapter 502, the Iowa Administrative Code, and Federal Regulation D of the Securities Act of 1933. The Bureau encourages individuals to seek legal counsel and to contact their respective state securities regulatory agency and the regional Securities and Exchange Commission office when they are dealing with any securities matter. The U.S. Securities and Exchange Commission web site may be found at www.sec.gov
If you have any questions concerning the applicability of Iowa Code Chapter 502 or Iowa Administrative Code Rules cited in this letter, please do not hesitate to contact the undersigned.
Thomas E. Alberts, Attorney
Iowa Securities and Regulated Industries Bureau