The complexity of a securities offering requires an issuer or fund sponsor to be familiar with key securities law terminology. The glossary below contains definitions and explanations of some of the more commonly used terms used in a private securities transaction or fund formation.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
Hedge fund administrators perform certain back office accounting, operations and valuation services. Administrators send periodic financial performance reports to investors, process subscriptions, calculate periodic net asset value for the fund portfolio, calculate performance compensation and perform many other important support functions.
Automatic Conversion is a clause found in certain convertible securities that, upon the occurrence of certain events, automatically changes the type of securities owned by an investor. For example, a promissory note may have a clause in which the promissory note automatically converts into 500 shares of common stock in the event that the company fails to make interest payments on the promissory note for four consecutive quarters.
anti-fraud provisions refer to Section 17(a) of the Securities Act of 1933 and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 that require issuers to make certain required disclosures to investors when offering and selling securities. Additionally, each state has its own securities fraud provisions.
The anti-fraud provisions prohibit the making of a misstatement or omission of a material fact in connection with an offering of securities. The company and its officers and directors can be held liable for violations. One of the key purposes of a private placement memorandum is to make full and adequate disclosure of the terms of a private offering to avoid violating the anti-fraud provisions, including carefully drafted risk factors.
An accredited Investor is an investor that meets certain income or net worth requirements set by the Securities and Exchange Commission under Rule 501 of Regulation D. For individuals, the income requirement is $200,000 annual income or $300,000 when combined with a spouse. The net worth requirement is $1,000,000 exclusive of the positive equity in the investors’ primary residence. In addition, the Securities and Exchange Commission broadened the definition in 2020 to include three licenses an individual can hold, in good standing, that may deem the individual an Accredited Investor, in lieu of meeting the financial threshold requirements. Read more here.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
Blue sky laws
Blue sky laws are state laws governing the issuance and registration of securities within that state. Blue sky laws contain registration requirements and anti-fraud provisions. Investment funds and most other private placement issuers rely on exemptions from the registration requirements of state law, most often Regulation D Rule 506. Even with the registration exemption, Regulation D issuers must still file a Form D notice filing and pay a state statutory fee in each state where investors have subscribed. This notice filing is often referred to as a “blue sky” filing.
In most states, issuers have fifteen days from the date of first subscription by an investor in a given state to make a blue sky filing. In New York, a company must pre-submit its blue sky filings before offering the securities in the state. New York’s Form D filing process is more onerous than other states, requiring a full submission of the Private Placement Memorandum and other offering documents.
A Broker-dealer is an individual or firm that purchases or sells securities for itself or on behalf of others, often acting as a placement agent. Broker-dealers must be registered with FINRA and are subject to extensive regulation. Only registered broker-dealers are permitted accept commissions or other transaction-based compensation for making capital introductions. So-called “finders” or unregistered placement agents that make capital introductions are not permitted to accept any form of transaction-based compensation for capital raising efforts.
Hedge funds and other investment funds and private issuers often rely on broker-dealers as placement agents to find capital. Due to increasing FINRA regulations, broker-dealers have heavy due diligence standards when offering private placements, which require them to scrutinize the risks of the offering. Accordingly, most broker-dealers are unwilling to sell private placements and it is very difficult for a start-up fund manager or a new company to find broker-dealers that are comfortable placing their securities. When a broker-dealer does agree to act as a placement agent for an issuer, the private placement memorandum must be submitted in advance to FINRA.
BVI (British Virgin Islands)
The British Virgin Islands (BVI) is a popular jurisdiction for offshore hedge funds and other private funds. The BVI and the Cayman Islands are the two most common offshore jurisdictions, with Cayman Islands being the more commonly used of the two. BVI has recently gained the reputation as being a cost-effective and convenient jurisdiction. BVI’s regulatory structure has sought to create a flexible jurisdiction with streamlined processes and strong legal certainty. BVI’s regulatory filing fees are considerably lower than those of the Cayman Islands.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
Capital Accounts (as used in LPs and LLCs)
A capital account is an account on the company’s books that shows the owner’s net investment in the company. It is calculated by taking the capital contribution of the owner, adding the owner’s share of company profits, and then subtracting the owner’s share of company losses in addition to the distributions or returns of capital. Capital accounts are used in limited partnerships, LLCs and other flow-through, partnership based entities.
The capital account concept is very important in hedge fund, particularly in calculating incentive compensation. The incentive compensation paid to a hedge fund manager is not a true “fee,” but an allocation from a limited partner’s capital account to the capital account of the hedge fund manager. This structure affects the tax attributes of the incentive compensation. Since the income in the capital account was never truly “allocated” to the limited partner, but allocated directly to the manager, theoretically, the manager is not deemed to have earned a fee for services, but realized an allocation of a capital account, which in some circumstances would change the tax characteristics of the income.
Cayman Islands, Offshore Fund Jurisdiction
The Cayman Islands is the world leader as a jurisdiction for hedge fund domicile, with the BVI coming in second. The Cayman Islands has historically been the top choice for offshore funds because of its business-friendly structure, stable government and well-developed investment laws. The Cayman Islands is a tax-exempt jurisdiction, allowing offshore investors and US tax-exempt investors (that would otherwise be subject to UBTI taxes) to avoid paying US taxes on hedge fund gains. In recent years the BVI has become an increasingly popular offshore fund jurisdiction, and offers streamlined flexibility and considerably lower fees than the Cayman Islands.
A Closed-end fund is an investment fund intended to last for a fixed term, usually between five to ten years. Investors in a closed-end fund are not generally permitted to make withdrawals or additional capital contributions. Most private equity funds, venture capital funds, and other funds investing in illiquid assets are structured as closed-end funds. Most hedge funds, on the other hand, invest primarily in liquid assets, and are open-end funds.
Closed-end funds typically require investors to make a legal commitment to invest in the fund (a capital commitment) at a future date when the fund managers are ready to deploy committed capital (a capital call). Closed-end funds typically use a distribution waterfall detailing how funds will be distributed when portfolio investments are sold. For example, an investor typically will receive his or her initial investment plus a specified preferred return before the fund manager receives distributions. Distribution waterfalls are multi-layered, and can be very complex, often containing clawback provisions requiring the general partner, or in some cases the investor, to return over-distributed assets.
Commodity Exchange Act
The Commodity Exchange Act prohibits fraudulent practices in trading futures contracts and other commodity derivatives, and provides for regulation of the managed futures industry. Any hedge fund manager trading in commodities or futures must comply with the Commodities Exchange Act.
Absent an exemption, funds trading commodities or futures must register as a commodity pool operator (CPO) with the Commodity Futures Trading Commission (CFTC), an independent federal agency that regulates the managed futures industry. Associated persons of a CPO must pass the Series 3 examination.
Investment advisors to separately managed accounts that make commodities futures recommendations must register with the CFTC as a commodity trading advisor (CTA).
CPO and CTA registration requires, among other things, membership in the National Futures Association (NFA), a self-regulating organization established by the CFTC to regulate the futures market.
(CFTC) Commodity Futures Trading Commission
The Commodity Futures Trading Commission (CFTC) is an independent federal agency created by the Commodity Exchange Act to regulate the commodities futures and commodities options markets in the United States. Absent an exemption, a hedge fund that trades commodities derivatives must register with the CFTC as a commodity pool operator (CPO) and its associated persons must pass the Series 3 examination.
CFTC registration requires membership in the National Futures Association (NFA), a self-regulatory organization responsible for overseeing the managed futures market.
(CPO) Commodity Pool Operator
A commodity pool operator is a pooled investment vehicle (including a hedge fund) that invests in futures.
The National Futures Association (NFA) defines a CPO as:
An individual or organization that operates a commodity pool and solicits funds for that commodity pool. A commodity pool is an enterprise in which funds contributed by a number of persons are combined for the purpose of trading futures contracts, options on futures, retail off-exchange forex contracts or swaps, or to invest in another commodity pool.
Unless an exemption applies, hedge funds that meet the above definition are required to register with the Commodity Futures Trading Commission (CFTC) as a CPO and become a member of the NFA. Association persons of a CPO are required to pass the Series 3 Examination. As part of the NFA membership application, hedge funds must submit offering documents to the NFA for its review and approval.
(CTA) Commodity Trading Advisor
A commodity trading advisor (CTA) is an individual or organization that, for compensation, provides advice regarding investment in commodities futures and other instruments covered by the Commodity Exchange Act. Absent an applicable exemption, such advisors must register with the Commodity Futures Trading Commission (CFTC) and become a member of the National Futures Association (NFA). Associated persons of a CTA must pass the Series 3 Examination.
Hedge fund managers that manage only pooled investment funds need not register as a CTA unless they manage separately managed accounts. Rather, most hedge fund managers trading futures would register as a commodity pool operator (CPO).
The SEC requires the RIA to provide a policies and procedures manual (Compliance Manual) outlining the advisor’s policies to protect investor interests and comply with advisor regulations.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
The Dodd-Frank Act is the Dodd-Frank Wall Street Reform and Consumer Protection Act, a federal law enacted in 2010. The Dodd-Frank Act brought sweeping changes to financial regulation affecting almost every component of the financial services industry.
The most monumental change for hedge fund regulation was an enactment found in Title IV, requiring previously exempt investment advisers to register under the Investment Advisors Act. Regulation resulting from Dodd-Frank also made changes to the definition of investor suitability standards of an “accredited investor” and and a “qualified client.”
Drag-Along Rights are rights that enable a majority equity holder to force a minority equity holder to accept a sale of its equity interests to a third-party purchaser for the price negotiated by the majority equity holder.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
An equity offering is an offering of securities that gives investors an ownership interest in the company. Examples of equity offerings include stock (common or preferred), limited partnership interests, or membership interests/units in a limited liability company.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
(FINRA) Financial Industry Regulatory Authority
Financial Industry Regulatory Authority (FINRA) is a regulatory agency that assists the SEC in regulating financial markets. Specifically, FINRA handles all the registrations of broker-dealers eligible to solicit investments to investors.
Additionally, all state and federal investment advisor registrations are processed through FINRA’s Investment Advisor Registration Depository (IARD) system. FINRA administers the various licensing examinations for the securities financial markets.
A finder is an individual who is not registered with FINRA as a broker-dealer, but who locates potential investors on behalf of an issuer and then facilitates an introduction between the investor and the company. A finder may not receive transaction-based compensation. Only registered broker-dealers may receive transaction-based compensation.
Forward-looking statements are statements made in a private placement memorandum or (or public securities disclosure) that are predictive of events to occur, but which have not actually occurred. They are predicated on certain assumptions. Should the statements fail to come to fruition, actual results, performances or goals could be materially different than those proposed. The use of forward-looking statements requires extreme care, and must be accompanied by appropriate explanatory language.
The SEC and most states require advisor representatives to submit a Uniform Application for Securities Industry Registration or Transfer (U-4), containing specific background information about the advisor representative.
The fund sponsor (also known as the fund manager) refers to either the individual or entity that manages and makes decisions about the investments in an investment fund.
To prevent funds from being forced to untimely liquidate investment positions to satisfy large redemption requests, most hedge funds limit the percentage of the portfolio that can be withdrawn in any given redemption period (often 10%-35% of Assets Under Management). This is known as a gate. In 2008-2009 a large number of funds invoked gate provisions to prevent assets from being sold at severe losses.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
High Water Mark
To prevent a manager from receiving duplicate performance compensation following periods of volatility, most funds allow investors to recoup past losses before the fund manager is entitled to receive additional performance compensation. To accomplish this, a high water mark (or loss carry forward provision) is established immediately following the allocation of incentive compensation. Under the “loss carry forward” terms, fund management is only entitled to be compensated for performance that exceeds the prior “high water mark.”
Some funds require the investment manager to achieve a certain level of return, either as a fixed percentage or a benchmark rate (such as LIBOR or the S&P 500) before managers are entitled to receive performance compensation. Hurdle rates can be either a “hard hurdle” or “soft hurdle.” A hard hurdle means that the manager only receives performance compensation that exceeds the hurdle rate. A soft hurdle means that no performance compensation is received if performance falls short of the soft hurdle rate, but once the soft hurdle rate is exceeded, the manager is entitled to the entire performance compensation.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
Intrastate Exemption–Rule 147
The Intrastate exemption is available if an issuer will only be offering securities in a single state. The exemption requires that the issuer be organized in the state it intends to offer its securities. It is a narrow exemption and can easily be lost if not followed exactly. There is no limit on the amount of securities that may be sold. The Intrastate exemption is quite restrictive and generally has limited usefulness to issuers, particularly when compared to Rule 506 offerings, which can typically provide the same exemptions, but with less chance for the issuer to lose its exemption. Because of the risk of losing the exemption, we generally recommend that the intrastate exemption be relied upon only as a backup to another exemption.
Investor Suitability Questionnaire
An investor suitability questionnaire is a document filled out by an investor seeking to purchase securities in a private offering. The questionnaire will ask for the investor’s contact information and ask the investor to attest that it meets the appropriate investor qualification standards required by the SEC.
An intermediary is a person or organization that acts a middleman between investors and companies raising funds. Intermediaries can include broker-dealers, regulated by FINRA, as well as unregistered finders. Care must be taken when entering into any transaction with a finder, since only registered broker-dealers are allowed to be paid transaction-based compensation for making a capital introduction.
(Also spelled “investment adviser”). Investment Advisors are firms or individuals that receive compensation for providing advice on investing in securities. Investment funds that invest in securities must either register with the appropriate jurisdiction as an investment advisor or satisfy an exemption.
Investment Advisor Representatives
Investment advisor representatives are individuals who work for investment advisory companies whose main responsibility is to provide investment advice. In addition to registration of the RIA firm, most states require each individual performing advisory services on behalf of an RIA firm to register as an investment advisor representative. Most states require advisor representatives to submit a Uniform Application for Securities Industry Registration or Transfer (U-4), containing specific background information about the advisor representative.
Investment Advisers Act of 1940
The Investment Advisers Act is a federal statute regulating individuals and entities that, for compensation, provide investment advice, analysis or recommendations regarding securities or securities markets. With the exception of Wyoming, each state has its own version of the investment advisers act. Hedge fund managers that invest in securities must comply with federal and state investment advisers act statutes.
Investment Management Agreement
The investment management agreement is an agreement between the fund and the investment management company (often the same entity as the general partner). It defines the services that a fund manager will provide. It gives the fund manager the broad discretionary authority to manage the fund’s investments in a manner that the fund manager believes is consistent with the investment strategy of the fund. Since the fund manager and the fund are controlled by the same individuals, the investment management agreement becomes a document signed by the same individuals on both sides.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
(JOBS Act) Jumpstart Our Business Startups Act
The JOBS Act is the Jumpstart Our Business Startups Act, a federal law that was enacted on April 5, 2012. This act loosened the restrictions on capital raising for small businesses, including requiring the SEC to lift the ban on advertising and solicitation on certain Regulation D and Rule 144A offerings.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
Limited Partnership Agreement
The limited partnership agreement (or in the case of an LLC-based fund, an operating agreement) is the legal governing document of the fund. The limited partnership agreement outlines the terms of the fund and rights of an investor and fund manager. In contrast with the private placement memorandum, which is written in plain english, the fund’s limited partnership agreement is a complicated legal document written in technical terms.
It is typical for a hedge fund to require an initial lock-up period of six months to one year or more before investors can withdraw invested funds, with monthly, quarterly or semi-annual redemption allowed thereafter. The lock-up period can be shortened or lengthened depending on the fund’s investment strategy, although any lock-up that extends beyond two years would likely be considered excessive by investors and the fund sponsor may consider a closed-end fund.
A management fee is assessed annually, typically ranging from 1% to 2% of the aggregate assets under management of a fund, regardless of the performance of the fund. The management fee is intended to cover manager salaries and general overhead. The management fee is deducted from each investor’s account periodically (in advance or arrears) as set forth in the offering documents.
A master-feeder fund structure is used to shield non-US investors from US taxation and US tax-exempt organizations from UBTI tax. This fund structure involves creating both an offshore and onshore feeder fund, and an offshore master fund in tax neutral jurisdictions (often the BVI or Cayman Islands) to facilitate investment by foreign investors and tax-exempt US investors. Investors invest in the appropriate feeder fund, which flows through to the master fund.
Material omissions are misstatements, willful or unintentional, or omissions of material facts in association with an offering of securities.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
(NFA) National Futures Association
The National Futures Association (NFA) is a self-regulated organization established by the Commodities Futures Trading Commission (CFTC) to regulate the managed futures markets to ensure compliance with the Commodities Exchange Act. The NFA acts as a watchdog organization to prevent commodities investment fraud.
Hedge funds investing in commodities derivatives must register as a commodity pool operator (CPO) with the CFTC unless an exemption applies. Individuals and companies that advise clients on separately managed accounts (non-pooled) must register as a commodity trading advisor (CTA). NFA membership (with its resulting oversight) is a precondition for registration with the CFTC. NFA membership requires associated persons of a CPO or CTA to pass the Series 3 Examination. CPOs that are hedge fund managers must submit hedge fund offering documents to the NFA for review prior to launching the fund.
National Securities Markets Improvement Act of 1996
The National Securities Markets Improvement Act of 1996 (NSMIA) was passed by Congress to amend and simplify former security acts to create one standard code for all companies and regulators. Because of NSMIA, offerings made in reliance of Rule 506 (either 506(b) or 506(c)) preempts state securities registration regulation.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
An operating agreement is the legal governing document for an LLC (similar to bylaws for a corporation or a limited partnership agreement for a limited partnership). This document specifies how ownership of the company is divided among the principals, voting issues, tax treatment, capital distribution and other important internal governance.
Private Placement Memorandum
A private placement memorandum (“PPM”), also known as a private offering document and confidential offering memorandum, is a securities disclosure document used in a private offering of securities. From an investor’s point of view, the purpose of a PPM is to obtain needed information about the company and the security being offered, both good and bad, to allow investors to make an informed decision about whether to purchase the security. From the company’s perspective, the purpose of a PPM is to provide the necessary disclosures about the company and its securities to protect the company against claims of misstatements or omissions.
The performance allocation is one of the defining characteristics of alternative funds (hedge funds, private equity funds and real estate funds), and distinguishes them from mutual funds, which are generally permitted to charge only management fees. The performance allocation is intended to align the interests of the fund manager with that of the investor and provide significant upside potential for fund managers.
A performance allocation is an agreed-upon percentage of the increase in the value of the fund assets allocated to the fund’s general partner as an incentive for positive performance. Performance allocations are usually a fixed percentage amount (usually around 20%), but can be set up as a sliding scale, such that the percentage increases as various performance thresholds are met. The Performance allocation is typically subject to a high-water mark and sometimes to a hurdle rate.
A Placement Agent assists the alternative investment community or private companies seeking to raise capital through private placement. Placement agents should be registered broker-dealers to accept transaction-based compensation.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
Hedge Fund managers that are subject to federal or state investment advisor registration may only earn a performance allocation from investors that are “qualified clients”. Under the federal Investment Advisors Act of 1940, and in most state investment advisor statutes, and qualified client is an individual that has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than $2,200,000 at the time the contract is entered into, exclusive of primary residence; or an individual or a company with at least $1,100,000 under management of the investment adviser.
Regulation D is a safe harbor SEC regulation promulgated under the Securities Act, which governs private placement securities exemptions, allowing issuers the ability to sell securities without registering with the SEC. Investment funds that have US investors almost always rely on Regulation D, specifically, Regulation D Rule 506(b) or Rule 506(c).
Regulation D Rule 504
Regulation D Rule 504 is governed by Section 3(b) of the Securities Act. This rule is a safe harbor provision for private offerings that will not exceed one million dollars, from an unlimited number of investors. A company that follows the requirements of Rule 504 is exempt from registering its securities with the SEC, but is still subject to state registration in each state in which the company offers securities, unless the company finds a state registration exemption. Thus, even in offerings of less than one million dollars, we recommend that issuers rely on Rule 506 rather than Rule 504 when possible, to avoid being subject to state registration requirements.
Rule 504 is most commonly used when the company needs to raise capital from more than 35 unaccredited investors and the company is not eligible for a Rule 506 exemption. In certain cases, Rule 504 may be used with general advertising without federal registration. However, such offerings would require registration or an appropriate exemption in every state in which it is offered.
Regulation D Rule 505
Regulation D Rule 505, like Rule 504, is governed by Section 3(b) of the Securities Act. It is a safe harbor provision for offerings that will not exceed five million dollars. Because of the benefits that are offered under Rule 506, this exemption is rarely relied upon, except as a backup exemption. Rule 505 permits the issuer to offer securities to no more than 35 unaccredited investors. This rule prohibits general solicitation or advertising to potential investors. Rule 505 requires that strictly prescribed information be given to the unaccredited investors, including audited financial statements.
Rule 10b-5 is an SEC regulation under the Securities and Exchange Act of 1934, which prohibits the use of false statements, omission of information and other deceptive practices in transactions involving stocks and securities. The company and its officers and directors can be held liable for violations.A | B | C | D | E | F | G | H | I | J | L | M | N | O | P | Q | R | S | T | U
A Small Corporate Offering Registration (SCOR) offering is essentially a more complex version of a Rule 504 Offering. The SCOR offering uses a standardized disclosure format that most states currently accept and relaxes some of the solicitation and advertising prohibitions that are prevalent in a Rule 504 Offering. The standardized disclosure format permits an issuer to comply with many of the state securities laws using one document and registering once, as opposed to preparing offering documents for each state and then filing such documents with each individual state. The standardized disclosure document is a question and answer document which is different than a typical PPM disclosure document.
Under a SCOR Offering, an issuer is limited to raising a maximum of one million dollars in a 12 month period. It must also provide two years of audited financial statements if the offering amount exceeds $500,000. Because of the burden of state registration, we would only recommend the SCOR offering in very limited circumstances, and when other exemptions are unavailable.
Securities are financial or investment instruments that represent ownership positions in a company, a creditor relationship with the company, or some derivative of either ownership or evidenced debt. Securities include a broad array of financial instruments, contracts and compensation schemes.
The legal test for establishing the existence of a “security” is found in the landmark case: SEC v. Howey (known as the Howey Test). Under the Howey Test, a financial relationship represents a security if there is:
i. an investment in a common enterprise;
ii. with the expectation of profits;
iii. expected to arise solely, or substantially, from the efforts of the promoter or third party.
There are certain categories of investments that are not considered securities, including commodities and futures (governed by the Commodity Futures Trading Commission (CFTC)) and certain real estate transactions. You should speak with an experienced attorney before concluding that any form of investment relationship does not involve a security.
Securities Act of 1933
The Securities Act of 1933, often referred to as the “Securities Act” is a federal statute that governs securities at issuance including the transparency of financial statements to ensure that investors can make informed decisions about investments.
This act establishes laws against misrepresentation and fraudulent activities in the securities market. Section 5 of the Securities Act requires that all non-exempt securities issuances be registered with the SEC. The most common exemption for an issuer of securities is Regulation D, which includes Rule 504, 505, and 506 (including the new Rule 506(c)).
Securities Exchange Act of 1934
The Securities Exchange Act of 1934, often referred to as the “Exchange Act” governs securities transactions after issuance (i.e. on secondary markets) and regulates the exchanges and broker-dealers in order to protect the public. The Exchange Act imposes ongoing reporting requirements on certain companies that have registered with the SEC under the Securities Act (reporting companies).
Private issuers, including private investment funds, seek to avoid the burdensome ongoing requirements of the Exchange Act by qualifying for exemption from registration under the Securities Act (most often under Regulation D, specifically Rule 506), making such private issuers also exempt from the ongoing reporting requirements of the Exchange Act.
Series 65 Examination
Most states require advisor representatives to pass the Series 65 examination (or an equivalent examination combination or professional designation). The Series 65 examination is a 130 question multiple choice test administered by FINRA covering topics such as: securities regulations, ethical guidelines, security products, methods for evaluating securities, securities trading strategies, principals of economics, and others.
Also known as a Parallel fund structure, a side-by-side structure has a U.S. fund and offshore fund that parallel each other in trading and have the same investment manager but maintain separate investment portfolios.
Most offering documents allow the management team to negotiate special terms (known as side letters) that are not applicable to other investors. Often the special arrangement involves better economic terms, such as reduced management or performance fees, or more convenient withdrawal terms. Care must be taken, however, not to allow side letters to prejudice other investors. For example, side letters that provide additional information rights or preferential liquidity treatment can present significant liability.
Side pockets are accounts designed to separate liquid from illiquid assets used in hedge funds.
A subscription agreement is an application by an investor to engage in a debt or equity securities transaction, whereby the issuing company agrees to sell securities at a specified price to the investor. The investor in turn agrees to pay that price for the securities. A subscription agreement for an equity transaction should be accompanied by a signature page to the company’s governing documents (operating agreement, limited partnership agreement, shareholders agreement, etc.). In a debt offering, the subscription agreement should be accompanied by a promissory note. An investor questionnaire, which establishes an investor’s suitability and qualification to invest in the transaction, is typically included or integrated with the subscription agreement.
Tag-along rights are rights that enable a minority interest holder to sell its shares to a third-party purchaser for the price negotiated by the majority interest holder and forces the third-party purchaser to purchase a proportionate share of the minority interest holder’s equity interest in the company as the majority.
Tax Matters Partner
A tax matters partner is a person in a partnership designated to receive tax notifications from the Internal Revenue Service and is given the authority to enter into tax agreements on the behalf of the partnership.
Any compensation of an individual or firm in the form of commission or sale of securities for capital introduction is transaction-based compensation. Transaction-based compensation may only be paid to FINRA registered broker-dealers.
The Unrelated Business Taxable Income (UBTI) tax applies to income generated by a tax-exempt organization by means of taxable activities. This type of income is generated outside of normal business operations. US tax-exempt investors, including RIAs and pension plans may be subject to UBTI if the fund employs leverage as part of its investment strategy (known as “acquisition indebtedness.” To avoid UBTI, such investors should invest through a tax-exempt offshore investment fund, most commonly, through a master-feeder or side-by-side structure in the Cayman Islands or BVI.