Successful investment funds rely heavily on the intellect and expertise of key individuals, the loss of which can prove ruinous to hedge funds of all sizes. In November 2014, one of Europe’s largest money managers, BlueBay, had to close a $1.4 billion fund because of the departure of a single key fund manager.
A company seeking to raise capital through a private placement generally looks to either debt or equity. Each has its respective advantages and disadvantages, both to the company and to the investor. An equity investment presents the investors with the possibility of a larger upside participation, but does not does not require the repayment of capital. A debt investments provides a periodic, fixed return to investors, but can put the company at risk if the company cannot timely meet its debt repayment obligations. If your company wants the benefits of debt without the risk of default, consider a hybrid approach: preferred equity.
Regulation D contains safe harbors that provide exemptions from federal registration. These include exemptions under Rules 504, Rule 505, and Rule 506. Rule 506 is the most commonly relied upon exemption in private offerings (accounting for more than 90% of offerings, according to SEC statistics).
Improper drafting of PPM disclosures often results in significant liability, even when the company did not overtly intend to deceive investors. The SEC and state securities commissions have developed a complex system of disclosure regulations, with which a company must comply for the securities to be deemed properly sold. In recent years, SEC regulations have undergone and continue to undergo major shifts, largely in response to the Dodd Frank Wall Street Reform and Consumer Protection Act (Dodd Frank) and the Jumpstart our Business Startups Act (JOBS Act). Failure to properly navigate the complex and continually changing regulations carries significant liability, including personal civil liability and criminal penalties in some cases.
A private placement offering’s basic structure involves either debt, equity, or some combination of debt and equity. Within the basic structure, an issuer has numerous options, from convertible securities (debts that convert to equity upon certain events), to priority distributions and resumptions. Not one structure fits every issuer. The offering structure is driven in large part by investor appetite for the particular investment.
In September 2103, the SEC adopted rules allowing private issuers of securities, including hedge funds, to engage in advertising and general solicitation under Regulation D. Until the recent CFTC announcement, hedge funds that include commodities or futures within their portfolios could not engage in general solicitation, since such instruments are regulated by the Commodities Futures Trading Commission (CFTC).
Filing the ADV and other registration documents is only the beginning of an RIA’s regulatory obligations. Following registration, RIAs and their representatives become subject to a network of complex compliance obligations. This article touches briefly on a few of the many components of RIA compliance, including: annual license renewals, detailed record keeping, investor disclosure, compliance/ethics manual issues, and preparing for audits. RIAs should work closely with an experienced investment management attorney to maintain compliance with its obligations.
A prime broker is a central broker through whom the fund executes most or all of its trades and who typically acts as custodian to the fund’s assets. When the hedge fund executes trades through other brokers, the prime broker works with the executing brokers to settle and transfer all assets through the prime broker.
There are two standards of investor suitability that may apply to investment fund investors, depending whether the fund manager is required to be registered as an investment adviser: the “accredited investor” standard or the significantly higher “qualified client” standard.
Hedge fund manager fees typically consist of (i) an annual management fee and (ii) a performance allocation, also referred to as incentive allocation, or carried interest. The latter is not technically a “fee,” but rather a capital allocation, as will be discussed below. This blog post describes the role of both compensation components.
Individuals and entities that provide securities investment advice for compensation are subject to state and federal investment advisor regulations. Anyone providing investment advice should consult an experienced investment management attorney to determine whether state or federal registration is required.
The central component of state or SEC investment advisor registration is Form ADV. Form ADV is divided into two parts, Part 1 and Part 2. Part 1 is a form requiring specific answers to questions asked, while Part 2 requires a written disclosure in narrative format covering certain required topics, which is ultimately delivered to existing and prospective clients. This article addresses Part 1 of ADV. For a discussion of the requirements of Part 2, see our article: Form ADV Part 2.
Part 2 of Form ADV is a written disclosure statement required for federal and state investment advisor registration. Form ADV is divided into Part 1 and Part 2. This article discusses Form ADV Part 2. See also our article discussing Form ADV Part 1.
Form D is a federal notice of an exempt securities offering and is the only disclosure document that is required to be filed with the SEC. This document discloses biographical information about the offering, the company, use of proceeds, and the principals of the company. Form D is not subject to a review or approval by the SEC, but is a required notification document. The federal Form D must be filed within fifteen days of the first sale to investors, an annual update must be filed as long as the offering remains open. Our firm offers issuers assistance in preparing and filing Form Ds as part of our flat-fee services. Form D is divided into two parts. The first part requests basic information about the issuer. The second part asks questions about the offering itself.