First time fund managers are often surprised to learn the degree to which their activities are constrained by regulation, particularly by federal and state securities regulation. Indeed, many fundraising practices that seem entirely unobjectionable to the normal businessperson violate these regulations in some circumstances. These rules can be “traps” that the unwary first time fund manager can fall into quite innocently.
Set out below is a list of five things you should not do in marketing a private investment fund.
1. Don’t Use Public Speaking Opportunities as a Chance to Pitch Your Fund. While it may seem like a great idea to tack a fundraising pitch onto the end of your speech to the local Kiwanis Club, it’s probably not. Despite the SEC’s adoption in 2013 of regulations implementing the JOBS Act that permit “general solicitation” for some private offerings, most fundraisings for private investment funds are still conducted under the “old rules” prohibiting general solicitation. Thus the traditional ban on general solicitation will most likely apply to your fundraising. Accordingly, once you begin the fundraising process you should be very careful about discussing your new fund in public settings.
2. Don’t Agree to Pay a Friend for Investor Leads. Few people suspect that paying someone a fee for soliciting investors can be illegal. But if the person you’re paying isn’t registered with the SEC as a broker-dealer then the person would most likely be violating federal law by accepting such a payment, and you would potentially be liable for aiding and abetting in that violation. Your unregistered agent might also be violating related state laws, and your investors may have a rescission right. And if a natural person is accepting payment in his own name, rather than on behalf of a firm, then you can be sure that he isn’t registered with the SEC as a broker-dealer.
3. Don’t Ignore SEC Guidance on Presenting Your Track Record. As a first time fund manager you will likely feel that your past investing track record is the most important criterion in determining whether a potential investor invests in your new fund. And you are probably right. But you will not have free reign in how you present your track record in your marketing materials – the SEC has had a lot to say on this subject. Because much of the SEC’s guidance in this area has been given in the context of charlatans outside of the private fund area, some of it may not make much sense to you. There may be restrictions on what particular deals you may and must include in your track record, and you will almost certainly have to disclose numbers that are net of fees and carry even if there were no fees and carry charged with respect to the investments that make up your track record. In addition, you may be required to include disclaimers with your track record that you would rather not. Finally, in some circumstances you may find that SEC guidance suggests that you are not permitted to use your track record at all, especially if your new team of investment professionals is not identical to the team that produced the results.
4. Don’t Accept a Subscription Without Reviewing Investor Questionnaire Answers Carefully. Now that you have your offering documents and your form of subscription document, you might think that there shouldn’t be any problem with your accepting subscriptions on that form, particularly as long as your new investors are completing all of the required paperwork. And, you might think that as long as the investors signed the subscription agreement and make all the standard representations, your fund is fine. But the specific answers given by your investors in that paperwork are very important. For example, an investor may have correctly completed the subscription document but indicated in its answers to the investor questionnaire that it is not a “qualified purchaser” for purposes of the Investment Company Act. Depending on the exemption from Investment Company Act regulation that you are relying on, accepting that investor’s commitment could cause you real problems. Additionally, if there are investors who says they are accredited or qualified solely because their beneficial owners are, you likely need to dig deeper and ensure those owners meet the required criteria.
5. Don’t Forget to Make Your Securities Filings. Remember that each time you accept a subscription from an investor your fund may have both federal and state securities filing obligations. Moreover, these obligations have a timing requirement – usually 15 days – and the securities regulators in many cases have prepared the forms that must be filed so that you may have to “turn yourself in” if you miss the deadline.
Henry Riffe practices corporate and commercial law at Robinson Bradshaw with an emphasis on private equity and venture capital transactions and mergers and acquisitions.