Interests in hedge funds are securities which mean that hedge fund managers must follow the federal (and state) laws regarding the sale of securities to investors.  Typically, securities will need to be registered under the Securities Act of 1933 unless there is an exemption from the registration provisions.

There are two main exemptions from the registration provisions – Section 4(2) of the Securities Act and the Regulation D (also known as “Reg D”) safe harbor rules promulgated by the SEC under Section 4(2).  Typically hedge funds will offer their securities pursuant to the Regulation D safe harbor and specifically under Rule 506 which allows a hedge fund to offer an unlimited amount of interests to investors.

Below is a quick synopsis of the Regulation D rules (I have left out Rule 507 and Rule 508).  I have also posted all of the rules here: Regulation D Rules.  Most important to hedge fund managers will be Rule 502 which requires that the manager not engage in any public solicitation and Rule 506.

Rule 501 – Definitions and Terms Used in Regulation D

In general this rule defines certain terms used in the rest of the rules.  The most important definition is probably the accredited investor definition.

Rule 502 – General Conditions to Be Met

In general, this rule discusses certain aspects of the offering which should be met.  A fund’s attorney will be familiar with these issues.

Specifically, this rule addresses certain integration issues, the information which must be provided to investors who are not accredited investors and the limits of resale of interests in a Regulation D offering.  Most importantly, the rule does not allow fund managers to engage in any sort of general solicitation.  Because this is really the most important aspect of the rule for hedge fund managers, I will include this section explicitly below:

c.  Limitation on manner of offering. Except as provided in Rule 504(b)(1), 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; and

2.    Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising;

Provided, however, that publication by an issuer of a notice in accordance with Rule 135c shall not be deemed to constitute general solicitation or general advertising for purposes of this section; Provided further, that, if the requirements of Rule 135e are satisfied, providing any journalist with access to press conferences held outside of the United States, to meeting with issuer or selling security holder representatives conducted outside of the United States, or to written press-related materials released outside the United States, at or in which a present or proposed offering of securities is discussed, will not be deemed to constitute general solicitation or general advertising for purposes of this section.

Because of the broadness of this rule, hedge fund managers should consult with their attorney if they have any question regarding the prohibition on general advertising.

Rule 503 – Filings of Notice of Sales

In general this rule outlines of the requirement for hedge fund managers to file Form D with the SEC within 15 days of the first sale of securities.  See link below on blue sky filings for more information.

Rule 504 – Exemption for Limited Offerings and Sales of Securities Not Exceeding $1,000,000

This rule is known as the intrastate offering exemption, and generally this provides an exemption from registration if the offering  of hedge fund interests is made wholly intrastate and if the amount to be raised is less than $1million.  Few if any hedge funds will utilize this exemption.

Rule 505 –  Exemption for Limited Offers and Sales of Securities Not Exceeding $5,000,000

In general, this rule provides that an offering is exempt from registration if the issuer raises $5 million or less over any 12-month time period.  This rule also provides that there can be no more than 35 non-accredited investors.

Rule 506 – Exemption for Limited Offers and Sales without Regard to Dollar Amount of Offering

In general, this rule provides that an offering is exempt from registration if the fund raises money from no more than 35 non-accredited investors, provided that all non-accredited investors, either alone or with his purchaser representative(s), has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment.  This rule does allow a hedge fund to sell an unlimited dollar amount of interests.

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The discussion below from the SEC on regulation D offerings is aimed more at hedge fund investors and the hedge fund due diligence which such investors should engage in; the discussion can be found here.  Managers are urged to discuss the Regulation D offerings with their hedge fund attorneys.

Regulation D Offerings

Under the Securities Act of 1933, any offer to sell securities must either be registered with the SEC or meet an exemption. Regulation D (or Reg D) contains three rules providing exemptions from the registration requirements, allowing some smaller companies to offer and sell their securities without having to register the securities with the SEC. For more information about these exemptions, read our publications on Rules 504, 505, and 506 of Regulation D.

While companies using a Reg D exemption do not have to register their securities and usually do not have to file reports with the SEC, they must file what’s known as a “Form D” after they first sell their securities. Form D is a brief notice that includes the names and addresses of the company’s executive officers and stock promoters, but contains little other information about the company.

If you are thinking about investing in a Reg D company, you should access EDGAR Company Search to determine whether the company has filed Form D. If the company has filed a Form D, you can request a copy. If the company has not filed a Form D, this should alert you that the company might not be in compliance with the federal securities laws.

You should always check with your state securities regulator to see if they have more information about the company and the people behind it. Be sure to ask whether your state regulator has cleared the offering for sale in your state. You can get the address and telephone number for your state securities regulator by calling the North American Securities Administrators Association at (202) 737-0900 or by visiting its website. You’ll also find this information in the state government section of your local phone book.
For more information about the SEC’s registration requirements and common exemptions, read our brochure, Q&A: Small Business & the SEC.

HFLB note: other articles you may be interested in are:

• Overview of New Form D
• Hedge Fund Blue Sky Filings
• Form D filing now done online

Please contact us if you have any questions.