Category Archives: Private Funds

Update: California Private Fund Adviser Exemption Submitted for Final Approval

On July 17, 2012 the California Department of Corporations Commission filed final amendments to Section 260.204.9 of Title 10 of the California Code of Regulations with the state’s Office of Administrative Law (OAL).  As reported here earlier this year, the amended regulation does away with the old private fund adviser exemption and creates a California corollary to the new federal private fund adviser exemption created by Dodd-Frank. Under California Gov. Code §11349.3. The OAL must approve or disapprove the regulation within 30 working days (the old exemption, extended by emergency regulation, remains in effect while the new regulation is under OAL review).

For additional information about the new regulations, or any other securities law concern, please contact Sarah Weber at or (619)298-2880.

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California Department of Corporations Announces Additional Changes to Proposed Private Fund Adviser Exemption

On June 18, 2012 the California Department of Corporations (DOC) published notice of additional changes to its proposed private fund adviser exemption regulation (10 CCR §260.204.9) and a new 15-day public comment period.

As reported earlier, the DOC’s proposed rule provides a California corollary to the new federal regulatory exemption for private fund advisers with assets under management of less than $150 million. Under the proposed rulemaking, certain California private fund advisers will be exempt from the DOC’s investment adviser registration requirement if the adviser: (1) is not subject to statutory disqualification under SEC Rule 262 of Regulation A; (2) files periodic reports on Form ADV containing the information required by federally exempt private fund advisers; and (3) pays an annual fee of $125. Under the DOC’s proposed rule, a private fund adviser is defined as an “investment adviser who provides advice solely to one or more qualifying private fund(s)” and a qualifying private funds is an issuer “that qualifies for the exclusion from the definition of an investment company under section 3(c)(1), 3(c)(5), or 3(c)(7) … of the Investment Company Act of 1940…”

The revised exemption was initially proposed on January 6, 2012. Comments received on that initial proposal resulted in a number of changes to the rule, necessitating the new public comment period. The changes to the proposed rule are fairly non-controversial. They include:

-Expansion of the definition of “qualifying private fund” to include issuers that qualify for an exclusion from registration as an investment company under Section 3(c)(5)of the Investment Company Act of 1940;

-For advisers who qualify for the exemption because their funds are excluded from registration as an investment company under Section 3(c)(1) or 3(c)(5) of the Investment Company Act of 1940:

  •  A requirement that audited financials to be prepared by a CPA that is registered with the PCAOB and be delivered to the fund’s investors within 120 days of the end of the fund’s fiscal year (or 180 days for a fund of funds), and
  • Prohibition of charging performance fees to any investor that is not a “qualified client” as defined by SEC Rule 205-3(d) (17 CFR § 275.205-3(d)); and

– Expansion of the definition of “venture capital company” to include corresponding federal definitions.

The existing California private fund exemption was extended to July 16, 2012, but cannot be extended again. The new rule, therefore, should be finally adopted by the Department no later than that date.

For additional information about reporting obligations of private fund advisers, or any other securities law concern, please contact Sarah Weber at or (619)298-2880.

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SEC Releases FAQs re: Form PF

On June 8, 2012 the SEC’s Division of Investment Management issued an initial set of frequently asked questions (FAQs) related to the filing of Form PF on the PFRD (Private Fund Reporting Depository). Investment advisers registered with the SEC and their related persons (including commodity pool operators and commodity trading advisers required to register as investment advisers) who manage one or more private funds with assets under management (AUM) of at least $150 million are required to file Form PF. The requirement came into effect last year with the SEC’s unanimous adoption of Rule 204(b)-1 under the Advisers Act (see this helpful article published by JLG last year on Form PF).  Under the rule, private fund advisers’ reporting obligations vary based on the type of private fund managed and the adviser’s AUM.

The topics covered by the new FAQs include:

  • Aggregation requirements for determining reporting status. The FAQ on aggregation clarifies that advisers with parallel managed accounts (i.e., a managed account that pursues substantially the same investment objective and strategy, and invests side by side in the same positions, as the private fund) should count the assets towards their AUM only if the parallel managed account is dependent on the private fund. A parallel managed account is dependent only if its value is less than the value of the private fund.
  • Timeframe for reporting when AUM or fund characteristics reach reporting thresholds. The FAQ explains that a private fund should be reported as a hedge fund for the particular quarter if it meets the definition of hedge fund on the last day of any month in the fiscal quarter immediately proceeding the fund’s most recently completed fiscal quarter. In other words, a fund with a fiscal year end of December 31st should be characterized as a hedge fund on September 30th if it met the definition on the last day of April, May or June.
  • Categorizations of funds for reporting purposes. This FAQ makes clear that if a private fund’s offering documents allow the fund to employ leverage or sell assets short, it must be characterized as a hedge fund – even if the fund does not actually employ such tactics.

The FAQs address fairly high level issues, disappointing some industry members who had been seeking more detailed guidance from the agency. The SEC has indicated it intends to release a second set of FAQs with further detail, but no timeline has been announced. For additional information about how to fulfill your Form PF obligations, or any other securities law concern, please contact Sarah Weber at or (619)298-2880.

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Update on CA Private Fund Advisers’ Registration

On February 6th the California Department of Corporations announced a 45-day extension of the comment period for its proposed rule aligning California’s exemption for private fund advisers to the federal exemption. Interested parties now have until 5 p.m. March 26, 2012 to provide commentary on the proposed rulemaking.

As reported by Core Compliance and Legal Services, Inc.,  on December 21, 2011, the DOC released its initial notice of proposed rulemaking concerning private fund adviser exemption. The overhaul of federal financial services and securities laws resulting from Dodd-Frank included the elimination of the “private adviser” exemption set forth in Section 203(b)(3) of the Investment Adviser Act of 1940 and the creation of a new regulatory regime for advisers to private funds.

The new provisions adopted by the SEC under Dodd-Frank exempt advisers to private funds from registration if they (1) exclusively advise venture capital funds or (2) manage less than $150 million of assets. The proposed California rule would likewise exempt advisers from state registration if they advise only “qualifying private funds” (defined by SEC Rule 203(m)-1). The California rule also includes several investor protection safeguards, including requiring that the exempt adviser not be subject to statutory disqualifications (also known as “bad boy” provisions) and requiring the adviser to file periodic reports on Form ADV containing the information required by exempt reporting advisers under SEC Rule 204-4.

If the proposal is adopted, California firms that solely manage qualifying funds (and meet the additional requirements) with under $150M in AUM may not be required to register with any regulatory agency. For additional information on the proposed regulation, please contact Sarah Weber at (619) 298-2880 or

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The End of the General Solicitation and Advertising Prohibition for Private Funds?

Earlier this month, the Managed Fund Association (“MFA”), the largest lobbyist for the alternative investment industry, petitioned the SEC to amend Rule 502(c) of Regulation D to eliminate the prohibition on general solicitation or general advertising with respect to private funds. This longstanding prohibition prevents private funds that are exempt from registration under the safe harbor of Reg D from engaging in “general solicitation” and “general advertising.” The ban, set forth in Rule 502(c), prohibits issuers from offering or selling “securities by any form of general solicitation or general advertising, including, but not limited to…Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio…”

The MFA asserts that technological changes, and Rule 502(c)’s innate vagueness, make compliance with the prohibition both unnecessarily risky for private funds and extremely costly to funds and the economy as a whole. Fund managers “expend considerable time and resources when making any sort of communications or participating in industry events, and often…refrain from such activity” entirely to avoid the risk of losing the protection of Reg D. This over-cautious stance results in a “lack of publically available, verified information about hedge funds,” which in turn has created the perception that “the industry [is] secretive,” likely “discourage[ing] institutional investors from allocating capital to private funds.”  The MFA argues that lifting the prohibition will lead to a change in this misperception about the industry and allow potential investors to “gather information about private funds at relatively low costs and lead to the more efficient allocation of capital.” MFA – and other supporters of this reform – assert that increased investment in such funds will fuel the economy since many hedge funds are exposed to risks that traditional retail investors commonly avoid.

The MFA’s petition is not the first call for the rollback of the advertising and solicitation ban for private funds. The Senate and the House both introduced legislation that would mandate similar changes to Reg D. Indeed, as noted in the MFA’s petition, the SEC itself has questioned the necessity of the ban with respect to the exemption under Section 3(c)(7) of the Investment Company Act , which only allows sales to “qualified purchasers” – defined as individuals with at least $5 million in investments and institutions with at least $25 million in investments . Only time will tell whether the SEC or Congress will implement reform, but the voices in favor of a change seem to be getting louder.

If you have any question about compliance with Reg D, or any other compliance concern, please post your comments here or contact the author at

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SEC No-Action Letter Provides Further Guidance for Private Fund Solicitors

As discussed in a previous blog posting, investment advisers must comply with Rule 206(4)-3 (the “Rule”) of the Investment Advisers Act of 1940 when using solicitors.  Notably, in July 2008, the SEC issued a no-action letter (the “Letter”) which provided additional guidance to Rule 206(4)-3’s applicability.  In this Letter, the SEC stated that Rule 206(4)-3 generally does not apply to a RIA’s cash payment to a person solely to compensate that person for soliciting investors or prospective investors for, or referring investors or prospective investors to, a private fund managed by the adviser.  In support of this interpretation, the SEC noted that: 

  1. Neither the Rule’s Proposing Release nor the Adopting Release contained any statement directly or indirectly suggesting that it would apply to RIAs’ cash payments to others solely to compensate them for soliciting investors for investment pools managed by the advisers;
  2. The Rule is designed so as to clearly apply to solicitations and referrals in which the solicited or referred persons might ultimately enter into investment advisory contracts with the investment adviser, yet private fund investors do not typically enter into investment advisory contracts with the investment advisers of the pools; and
  3. The Rule’s use of the terms “client” and “prospective client,” rather than “investor” or “prospective investor,” also strongly suggests that the Rule was intended to apply to solicitations and referrals in which the solicited or referred persons might ultimately enter into investment advisory contracts with the investment adviser.

Whether a RIA’s cash payment to a person is being made solely to compensate that person for soliciting investors for an investment pool managed by the adviser will depend upon all surrounding facts and circumstances.   For example, the Rule would not appear to apply to a RIA’s cash payment to a person for referring other persons to the adviser where the adviser manages only investment pools and is not seeking to enter into advisory relationships with other persons. In contrast, the Rule would appear to apply if the adviser manages or seeks to manage investment pools and individual accounts, is seeking to enter into investment advisory relationships with other persons, and the adviser’s cash payment, under the adviser’s arrangement with the referring person, compensates the referring person for referring the other persons as prospective advisory clients.

For more information, please contact Brent Cunningham, Associate, at (619) 298-2880 or at

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Advances in Technology May Prompt the SEC into Revising Securities’ Registration Requirements

In November of 2009, two advertising executives, and longtime fans of Pabst Brewing Company (“PBR”), attempted to purchase the company. The advertising executives made offers for the company, but could not approach the $300 million asking price. In order to raise capital for the buyout, the advertising executive utilized “crowd funding.” Crowd funding is the use of social media and the internet to organize a large group of individuals to achieve a common goal, in this instance, to raise capital for the purchase of a brewery. Accordingly, the advertising executives decided to solicit online pledges in exchange for a “certificates of ownership” and beer equal to the amount pledged. To that end, the advertising executives established the website to facilitate and centralize their fundraising efforts. They also formed a FaceBook page and Twitter account for to help generate interest and publicity for the buyout. Shockingly, the two advertising executives ultimately received pledges of $200 million from over five million people. While the $200 million dollars was not enough to purchase PBR, it was enough to catch the attention of the Securities and Exchange Commission (“SEC”), who in June of this year issued a Cease and Desist Order[1] against the two advertising executives for violation of federal securities laws.

Under the Securities Act of 1933, the offer or sale of securities is prohibited unless registered or exempt from registration.[2] The list of what constitutes a “security” for purposes of the Securities Act of 1933 is long, but its contours were fleshed out in the seminal Supreme Court case SEC v. Howey.[3]  Under Howey, a “security” is defined as an exchange of money with an expectation of profits arising from a common enterprise which depends solely on the efforts of a promoter or third party. Clearly, under Howey, any crowd funding arrangement (like that conducted for PBR) in which people are asked to contribute money in exchange for potential profits based on the work of others would be considered a security. Consequently, the attempt to raise money by soliciting millions of small pledges from people on Facebook or Twitter in exchange for a “certificate of ownership” was in direct violation of the Securities Act of 1933.

 Likely given the amount of time, effort and cost associated with registering their “certificates of ownership,” the advertising executives unsurprisingly ignored this requirement, and took their capital raising efforts directly to the people.[4] An alternative method of complying with federal securities laws may have been available if the advertising executives, and similarly situated crowd funders, would have used an exemption from the registration requirement, such as those afforded under Regulation D.  However, given the facts and circumstances surrounding the offering, it is doubtful as to whether they would have qualified for an exemption. 

Current Regulatory Framework:  Rules 504, 505 and 506 under Regulation D of the Securities Act of 1933 are the most commonly used exemptions to avoid the registration requirement.  Summarily, Rule 504 provides an exemption for certain offerings not exceeding an aggregate of $1 million within a 12-month period.  Given the $300 million buyout price of the brewery and the amount of money that is commonly attempted to be raised by crowd funders, the $1 million cap of Rule 504 often renders this exemption unavailable. Similarly, Rule 505 oftentimes does not suit crowd funders’ purposes because this exemption is capped at offerings not exceeding $5 million within a 12-month period and places a limit on the number of investors who are not “accredited investors.”[5]  While Rule 506 does not place a cap on the amount of the offering or the number of accredited investors, such an offering is limited thirty five non-accredited investors who must also meet certain sophistication requirements.  Consequently, given the fact that over five million people provided funds to the advertising executives, this offering could not be exempted under Rule 506.  Moreover, given that Rules 504, 505 and 506 all prohibit general solicitation or advertising of the investment opportunity, attempts at exempting crowd funding efforts under these Rules is not available.

 What is On the Horizon: Loosening the restrictions on entrepreneurs’ ability to raise capital through crowd funding offers numerous benefits.  For instance, crowd funding allows entrepreneurs to quickly and easily reach investors who are interested in backing their product or services, and may spur the economy through the facilitation of small business formation.  Moreover, jobs are likely to be created as small businesses are born or grow through their ability to access capital through crowd funding.  For these reasons, Representative Darrell Issa, Chairman of the Committee on Oversight and Government Reform, and Mary Shapiro, Chairman of the SEC, have been corresponding on ways to address changes in the securities laws governing initial public offerings and capital formation and raising.[6]

[1] SEC Enters Cease and Desist Order in Connection with Online Campaign to Buy Beer Company (June 8, 2011) available at

[2] 15 U.S.C. § 77e.

[3] SEC v. W. J. Howey Co., 328 U.S. 293 (1946).

[4] According to the SEC’s Cease and Desist Order, at least one of the advertising executives met with counsel, and it was thought that they had discussed the possibility of an initial public offering, which would have required the registration of the “certificates of ownership.”  See id.

[5] Among other things, “Accredited Investors” have certain sophistication requirements but are commonly defined asnatural persons whose individual net worth, or joint net worth with that person’s spouse, at the time of the purchase exceeds $1,000,000. See 17 C.F.R. § 230.215.

[6] See letter from Chairman Mary L. Schapiro to The Honorable Darrell E. Issa, dated April 6, 2011, available at

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