Articles Posted in Private Funds

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Written by: Jay B. Gould

On December 12, 2013, the Securities and Exchange Commission (SEC) charged a London-based hedge fund adviser and its former U.S.-based holding company with internal controls failures that led to the overvaluation of a fund’s assets and inflated fee revenue for the firms.  The investigation came out of the SEC’s Aberrational Performance Inquiry, pursuant to which the Enforcement Division’s Asset Management Unit identifies suspicious performance through risk analytics.  The SEC searches for performance that is inconsistent with a fund’s investment strategy or other benchmarks and then conducts follow up inquiries.  In this case, the SEC worked with the United Kingdom’s financial regulator, the Financial Conduct Authority.

According to the SEC’s order instituting settled administrative proceedings, the GLG firms managed the GLG Emerging Markets Special Assets 1 Fund.  From November 2008 to November 2010, GLG’s internal control failures caused the overvaluation of the fund’s 25 percent private equity stake in an emerging market coal mining company.  The overvaluation resulted in inflated fees to the GLG firms and the overstatement of assets under management in the holding company’s filings with the SEC. 

The SEC order also stated that GLG’s asset valuation policies required the valuation of the coal company’s position to be determined monthly by an independent pricing committee.  On a number of occasions, GLG employees received information calling into question the $425 million valuation for the coal company position.  The SEC found that there were inadequate policies and procedures to ensure that such relevant information was provided to the independent pricing committee in a timely manner or even at all.  There also appeared to be confusion among GLG’s fund managers, middle-office accounting personnel, and senior management about who was responsible for elevating valuation issues to the independent pricing committee.  

The SEC’s order found that GLG Partners L.P. violated and GLG Partners Inc. caused numerous violations of the Federal securities laws.  It also required the GLG firms to hire an independent consultant to recommend new policies and procedures for the valuation of assets and test the effectiveness of the policies and procedures after adoption.  The GLG firms agreed to pay disgorgement of $7,766,667, prejudgment interest of $437,679, and penalties totaling $750,000.

The SEC has been targeting valuation cases recently as evidenced by the recent enforcement action against the Morgan Keegan fund directors and in the Ambassador Capital case.  Fund managers should review their valuation policies and procedures to make sure that such policies and procedures address current regulatory concerns, and to make sure that the disclosures in their fund documents are consistent with actual practice.

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Written by: Jay B. Gould, Michael G. Wu and Jessica M. Brown

In January, 2010, the Securities and Exchange Commission (“SEC”) announced its Enforcement Cooperation Initiative (“Initiative”), which provided the SEC with the ability to offer certain individuals or entities immunity or other preferential treatment in exchange for information about illegal activities and/or cooperation with the SEC in connection with SEC enforcement actions. These techniques, such as cooperation and immunity agreements, or deferred and non-prosecution agreements were adopted by the SEC as a result of their effectiveness against organized crime investigations and the then recent hires by the SEC from the U.S. Attorney’s Office which regularly employs those tools. 

For a full description of the types of agreements in which the SEC may enter with an enforcement target or other “person of interest,” see the 2013 Enforcement Manual HERE.  Since the Initiative began, the SEC has entered into thirteen cooperation agreements, three deferred prosecution agreements and four non-prosecution agreements. See those agreements on the Initiative website HERE.

On November 12, 2013, the SEC announced its first deferred prosecution agreement with an individual. Scott Herckis (“Herckis”) had brought to the attention of the SEC certain fraudulent activities at the Heppelwhite Fund LP, where he acted as fund administrator through his financial and accounting services firm, SJH Financial, LLC. With the information and materials provided by Herckis, the SEC was able to bring an enforcement action against fund manager Berton Hochfeld for misappropriating over $1.5 million from the fund and overstating performance. The harmed Heppelwhite investors have since been granted a $6 million distribution by a federal judge.

After Herckis became aware of the fraudulent scheme, his actions and omissions enabled the scheme to continue for many months, yet without his cooperation and information, the scheme may have gone undetected. The deferred prosecution agreement provides for sanctions and penalties against Herckis for his role in the fraud but no further action will be taken against him for his violations, provided he does not violate the terms of the agreement.  This leaves industry participants pondering what further action the SEC would have taken against Herckis had he not cooperated and what the value of a deferred prosecution agreement might really be. Click HERE to read the Herckis deferred prosecution agreement.  

The SEC and federal prosecutors are continuing to explore alternative approaches to penalize companies and their principals for what they consider egregious securities law violations. In the recent criminal proceeding of SAC Capital Advisors LP (“SAC”), prosecutors considered whether criminal charges under the Racketeer Influenced and Corrupt Organizations Act (“RICO”) would be appropriate. RICO allows for criminal charges, with substantial penalties, against the leader of an organization for acts that they ordered others to commit. Traditionally RICO has been successfully used against organized crime figures.  Federal prosecutors have taken the position that RICO may also be successfully used against the leaders of a legal entity, which could greatly increase the potential personal liabilities that an executive may face.  Although the SEC has now incorporated certain enforcement techniques used by criminal prosecutors, the SEC can only bring civil actions against alleged wrongdoers, but it can, and with increasing frequency does, refer cases over to the Justice Department for criminal prosecution.

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Written by:  Jay B. Gould and Jessica M. Brown

On October 28, 2013, the Securities and Exchange Commission (“SEC”)  brought enforcement actions and imposed sanctions on three different registered advisers and their principals for violations of Rule 206(4)-2 under the Investment Advisers Act of 1940 (the “Custody Rule”).  The circumstances that gave rise to each adviser being deemed to have custody differed, however, certain violations of the Custody Rule were present in each case.  These advisers were sanctioned for (i) incorrectly reporting their custody of client assets on their Form ADV, (ii) not conducting a surprise audit by an independent public accountant to verify client assets in custody, (iii) not having a reasonable belief that a qualified custodian was delivering account statements to fund investors at least every quarter, and (iv) a lack of properly written policies and procedures to protect client assets in custody.

This interest by SEC examination and enforcement staff should come as no surprise to investment advisers.  Each year, the SEC publishes a list of areas on which examiners will focus their efforts during the year.  The 2013 examination priority publication listed the Custody Rule as the first item on the priority list.  The SEC clearly stated to the industry that examinations of investment advisers would scrutinize the adviser’s (i) understanding of what constitutes custody, (ii) compliance with the “surprise exam” requirement of the Custody Rule, (iii) satisfaction of the “qualified custodian” provision and, (iv) if applicable, proper use of the exception for pooled investment vehicles.

Generally, any adviser that has access to a client’s account or assets, or has an arrangement in place that permits it to withdraw client assets, must comply with the Custody Rule.  An exception to the annual surprise audit and account statement delivery requirements are available for advisers that have custody of private fund or hedge fund assets, as long as certain conditions are met.

Because the definition of custody is both broad and somewhat convoluted, advisers should regularly review how client assets are maintained to determine if they have custody of client assets within the meaning of the Custody Rule and, if so, whether their compliance procedures, regulatory disclosures and marketing materials accurately reflect current business practice.  Investment advisers should always stay familiar with what the SEC has determined will be examination and enforcement priorities.

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Pillsbury was recently recognized for the second time as the “Best Onshore Law Firm – Hedge Fund Start-Ups” at the 2013 HFMWeek U.S. Hedge Fund Service Awards in New York City. This marks the fifth consecutive year Pillsbury has been honored by HFMWeek for its service to the hedge fund community. Pillsbury also won the HFMWeek Award for “Best Onshore Law Firm – Client Service” in 2009, 2010 and 2011.

The awards were established to recognize organizations that have outperformed their peers through the volatility of the last year, by demonstrating exceptional customer service or innovative product development. Winners are determined by a panel of independent industry experts who look at a combination of quantitative and qualitative measures.

Partner Jay Gould, leader of Pillsbury’s Investment Funds & Investment Management practice team, accepted the award on behalf of the Investment Funds & Investment Management team.

“HFMWeek’s recognition of Pillsbury and our work for clients organizing new investment advisers and offering new funds is even more meaningful because these are pivotal days for the industry, which faces relentless competition, global economic uncertainty and entirely new regulatory controls—particularly here in the U.S.,” Gould said. “This award reflects the understanding by both investors and fund managers that new hedge fund managers need to partner with the very best in class legal team in order to be and remain competitive in today’s highly scrutinized markets.”

HFMWeek serves the international hedge fund community, covering all aspects of operating a successful hedge fund. Pillsbury prevailed over top U.S. firms that also practice in the funds management area.

The team posts analysis of legal and business issues at Pillsbury’s Investment Fund Law Blog.

About Pillsbury Winthrop Shaw Pittman LLP

Pillsbury is a full-service law firm with an industry focus on energy & natural resources, financial services including financial institutions, real estate & construction, and technology. Based in the world’s major financial, technology and energy centers, Pillsbury counsels clients on global business, regulatory and litigation matters. We work in multidisciplinary teams that allow us to understand our clients’ objectives, anticipate trends and bring a 360-degree perspective to complex business and legal issues—helping clients to take greater advantage of new opportunities, meet and exceed their objectives and better mitigate risk. This collaborative work style helps produce the results our clients seek.

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Written by: Jay B. Gould

On October 23, 2013, the Securities and Exchange Commission (“SEC”) voted unanimously to propose rules under the JOBS Act to permit companies to offer and sell securities through crowdfunding.

Crowdfunding describes an evolving method of raising capital that has been used outside of the securities arena to raise funds through the Internet for a variety of projects, products or artistic endeavors. Crowdfunding has generally not been used as a means to offer and sell securities because offering a share of the financial returns or profits from business activities would likely trigger the registration provisions of the federal securities laws relating to the offer or sale of securities.

Title III of the JOBS Act created an exemption under the securities laws so that this type of funding method can also be used to offer and sell securities without registration. The JOBS Act established the framework for a regulatory structure for this funding method. It also created a new entity – a funding portal – to allow Internet-based platforms or intermediaries to facilitate the offer and sale of securities without having to register with the SEC as brokers. Crowdfunding should not be confused with rules that were recently adopted under Regulation D that permits issuers of securities of private companies to engage in general solicitation or public advertising related to the sales of such securities.

The intent of the JOBS Act was to make it easier for startups and small businesses to raise capital from a wide range of potential investors and provide additional investment opportunities for investors. Critics, led by consumer groups and state securities administrators, have been critical of both the Regulation D amendments regarding general solicitation, as well as the crowdfunding provisions, as opening the floodgates for fraudster to prey on the financially unsophisticated. Accordingly, the challenge for the SEC is to establish a regulatory structure that both permits small companies and entrepreneurs to access investors in an efficient manner, while protecting the investors from scam artists.

Proposed Rules
The proposed rules would among other things permit individuals to invest subject to certain thresholds, limit the amount of money a company can raise, require companies to disclose certain information about their offers, and create a regulatory framework for the intermediaries that would facilitate the crowdfunding transactions.

Under the proposed rules:

  • A company would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
  • Investors, over the course of a 12-month period, would be permitted to invest up to:

$2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.

10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

Certain companies would not be eligible to use the crowdfunding exemption. Ineligible companies include non-U.S. companies, companies that already are SEC reporting companies, certain investment companies (such as hedge funds), companies that are disqualified under the proposed disqualification rules, companies that have failed to comply with the annual reporting requirements in the proposed rules, and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.

Securities purchased in a crowdfunding transaction cannot be resold for a 12-month period. Holders of these securities would not count toward the threshold that requires a company to register with the SEC under Section 12(g) of the Securities Exchange Act of 1934.

Disclosure by Companies
The proposed rules would require companies conducting a crowdfunding offering to file certain information with the SEC, provide it to investors and the relevant intermediary facilitating the crowdfunding offering, and make it available to potential investors.

In its offering documents, among the things the company would be required to disclose are:

  • Information about officers and directors as well as owners of 20 percent or more of the company.
  • A description of the company’s business and the use of proceeds from the offering.
  • The price to the public of the securities being offered, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount.
  • Certain related-party transactions.
  • A description of the financial condition of the company.
  • Financial statements of the company that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company’s tax returns or reviewed or audited by an independent public accountant or auditor.

Companies would be required to amend the offering document to reflect material changes and provide updates on the company’s progress toward reaching the target offering amount.

Companies relying on the crowdfunding exemption to offer and sell securities would be required to file an annual report with the SEC and provide it to investors.

Crowdfunding Platforms
Title III of the JOBS Act requires that crowdfunding transactions take place through an SEC-registered intermediary, either a broker-dealer or a funding portal. Under the proposed rules, the offerings would be conducted exclusively online through a platform operated by a registered broker or a funding portal, which is a new type of SEC registrant.

The proposed rules would require these intermediaries to:

  • Provide investors with educational materials.
  • Take measures to reduce the risk of fraud.
  • Make available information about the issuer and the offering.
  • Provide communication channels to permit discussions about offerings on the platform.
  • Facilitate the offer and sale of crowdfunded securities.

The proposed rules would prohibit funding portals from:

  • Offering investment advice or making recommendations.
  • Soliciting purchases, sales or offers to buy securities offered or displayed on its website.
  • Imposing certain restrictions on compensating people for solicitations.
  • Holding, possessing, or handling investor funds or securities.

The proposed rules would provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.

What’s Next?
The SEC will take public comments on the proposed rules for 90 days, after which it will review the comments and determine whether to adopt the proposed rules. Depending upon the tone and substance of the comments, the SEC may move quickly to adopt the rules as proposed, adopt the rules with certain modifications based on the comments, or re-propose the rule for additional public comment. Anxious market participants should not expect to start offering their crowdfunding securities.

Follow @Investment_Law on Twitter.

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This article was published by Business in Canada and is reprinted here with permission.

Business in Canada recently had the opportunity to interview Richard Taglianetti, a giant in the hedge fund universe who has raised millions of dollars for start-up managers over the course of his career. At present, Richard serves as the senior managing director of hedge funds at Corinthian Partners, where he connects institutional investors on both sides of the Atlantic with emerging managers who have logical, scalable processes and strong track records, to boot.

During the interview, we discussed the challenges facing the Canadian hedge fund industry and why its size pales in comparison to the United States and the United Kingdom. Consider this: the population of United States is roughly ten times that of Canada, but its hedge fund managers oversee roughly 45 times the assets. At the end of 2012, Canadian hedge funds managed about $35 billion while their counterparts in the United States had a cumulative AUM of over $1.5 trillion. In light of this vast discrepancy, Richard concluded that “there’s definitely something holding the Canadian hedge fund industry back.”

Shortly thereafter, Richard was kind enough to follow up with Business in Canada, sending an email in which he outlined a few things that are inhibiting the growth of hedge funds in the Great White North.

  • Underperformance

As Richard previously told us, “Performance is a magnet for assets.”  Unfortunately, in 2012, Canadian hedge funds did more to repel than attract investors.  As a whole, the industry gave back 5 percent last year, far underperforming the TSX, which advanced by 4 percent.

  • The End Of The Commodities Supercycle

Before ‘tapering’ became part of Wall Street’s lexicon, investors were rebalancing their portfolios in accordance with the notion that the commodities supercycle was drawing to a close.  Richard believes this development had a particularly deleterious effect on resource-focused managers in Canada.

  • The Cost Of Accessing FundSERV

FundSERV is an online hub that connects and facilitates transactions between funds, distributors, and intermediaries. Membership in this network doesn’t come cheap.  According to Richard, these costs unduly burden smaller managers, which reduces the size of the pool of managers in Canada. In addition, this restricts a hedge fund’s access to high net worth investors, who provide the vital money needed for expansion.

Richard is quite open to working with Canadian managers, saying, “If there was a team in Canada that is performing, I would love to talk to them.”  But after 13 years of putting out global searches for managers, only a handful of Canadians have answered his call. 

Author: BiC Editorial Board

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Written by:  Jay B. Gould

On September 17, 2013, the Securities and Exchange Commission (“SEC”) announced enforcement actions against 23 firms for short selling violations as the agency increases its focus on preventing firms from improperly participating in public stock offerings after selling short those same stocks.  The enforcement actions are being settled by 22 of the 23 firms charged, resulting in more than $14.4 million in monetary sanctions.  

The SEC’s Rule 105 of Regulation M prohibits the short sale of an equity security during a restricted period, which is generally defined as five business days before a public offering – and the purchase of that same security through the offering.  The rule applies regardless of the trader’s intent, and promotes offering prices that are set by natural forces of supply and demand rather than manipulative activity.  The rule is intended to prevent short selling that can reduce offering proceeds received by companies by artificially depressing the market price shortly before the company prices its public offering.

The firms charged in these cases allegedly bought offered shares from an underwriter, broker, or dealer participating in a follow-on public offering after having sold short the same security during the restricted period.   

“The benchmark of an effective enforcement program is zero tolerance for any securities law violations, including violations that do not require manipulative intent,” said Andrew J. Ceresney, Co-Director of the SEC’s Division of Enforcement.  “Through this new program of streamlined investigations and resolutions of Rule 105 violations, we are sending the clear message that firms must pay the price for violations while also conserving agency resources.” 

The SEC’s National Examination Program simultaneously has issued a risk alert to highlight risks to firms from non-compliance with Rule 105.  The risk alert highlights observations by SEC examiners focusing on Rule 105 compliance issues as well as corrective actions that some firms proactively have taken to remedy Rule 105 concerns.

In a litigated administrative proceeding against G-2 Trading LLC, the SEC’s Division of Enforcement is alleging that the firm violated Rule 105 in connection with transactions in the securities of three companies, resulting in profits of more than $13,000.  The Enforcement Division is seeking disgorgement of the trading profits, prejudgment interest, penalties, and other relief as appropriate and in the public interest.  

The SEC charged the following firms in this series of settled enforcement actions:

  • Blackthorn Investment Group – Agreed to pay disgorgement of $244,378.24, prejudgment interest of $15,829.74, and a penalty of $260,000.00.
  • Claritas Investments Ltd. – Agreed to pay disgorgement of $73,883.00, prejudgment interest of $5,936.67, and a penalty of $65,000.00.
  • Credentia Group – Agreed to pay disgorgement of $4,091.00, prejudgment interest of $113.38, and a penalty of $65,000.00.
  • D.E. Shaw & Co. – Agreed to pay disgorgement of $447,794.00, prejudgment interest of $18,192.37, and a penalty of $201,506.00.
  • Deerfield Management Company – Agreed to pay disgorgement of $1,273,707.00, prejudgment interest of $19,035.00, and a penalty of $609,482.00.
  • Hudson Bay Capital Management – Agreed to pay disgorgement of $665,674.96, prejudgment interest of $11,661.31, and a penalty of $272,118.00.
  • JGP Global Gestão de Recursos – Agreed to pay disgorgement of $2,537,114.00, prejudgment interest of $129,310.00, and a penalty of $514,000.00.
  • M.S. Junior, Swiss Capital Holdings, and Michael A. Stango – Agreed to collectively pay disgorgement of $247,039.00, prejudgment interest of $15,565.77, and a penalty of $165,332.00.
  • Manikay Partners – Agreed to pay disgorgement of $1,657,000.00, prejudgment interest of $214,841.31, and a penalty of $679,950.00.
  • Meru Capital Group – Agreed to pay disgorgement of $262,616.00, prejudgment interest of $4,600.51, and a penalty of $131,296.98.00.
  • Merus Capital Partners – Agreed to pay disgorgement of $8,402.00, prejudgment interest of $63.65, and a penalty of $65,000.00.
  • Ontario Teachers’ Pension Plan Board – Agreed to pay disgorgement of $144,898.00, prejudgment interest of $11,642.90, and a penalty of $68,295.
  • Pan Capital AB – Agreed to pay disgorgement of $424,593.00, prejudgment interest of $17,249.80, and a penalty of $220,655.00.
  • PEAK6 Capital Management – Agreed to pay disgorgement of $58,321.00, prejudgment interest of $8,896.89, and a penalty of $65,000.00.
  • Philadelphia Financial Management of San Francisco – Agreed to pay disgorgement of $137,524.38, prejudgment interest of $16,919.26, and a penalty of $65,000.00.
  • Polo Capital International Gestão de Recursos a/k/a Polo Capital Management – Agreed to pay disgorgement of $191,833.00, prejudgment interest of $14,887.51, and a penalty of $76,000.00.
  • Soundpost Partners – Agreed to pay disgorgement of $45,135.00, prejudgment interest of $3,180.85, and a penalty of $65,000.00.
  • Southpoint Capital Advisors – Agreed to pay disgorgement of $346,568.00, prejudgment interest of $17,695.76, and a penalty of $170,494.00.
  • Talkot Capital – Agreed to pay disgorgement of $17,640.00, prejudgment interest of $1,897.68, and a penalty of $65,000.00.
  • Vollero Beach Capital Partners – Agreed to pay disgorgement of $594,292, prejudgment interest of $55.171, and a penalty of $214,964..
  • War Chest Capital Partners – Agreed to pay disgorgement of $187,036.17, prejudgment interest of $10,533.18, and a penalty of $130,000.00.
  • Western Standard – Agreed to pay disgorgement of $44,980.30, prejudgment interest of $1,827.40, and a penalty of $65,000.00.
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This article was published by The FCPA Report and is reprinted here with permission.

More and more, venture capital firms are investing in start-ups seeking to expand internationally or with nascent cross-border operations in place.  Such investments offer opportunities for lucrative returns but also carry significant anti-corruption risk that VC firms are often ill-equipped to manage.  For many businesses, managing anti-corruption risk is a necessary cost center.  But VC firms are uniquely positioned to use that risk to drive a better deal and gain greater control over management and direction of the business.

The overlapping and increasingly aggressive anti-corruption regimes, including the FCPA, the U.K. Bribery Act, the anti-bribery laws in China, Germany and the newly enacted law in Brazil, coupled with the heightened risk of corruption in emerging economies, can quickly derail an otherwise strong investment.  Not only are VC firms subject to fines, penalties and reputational harm through the conduct of the start-up, but the conduct itself may have occurred before the VC firm even considered taking a stake.

This article offers an assessment of the opportunities and risks that VC firms should consider, and concludes with four strategies for maximizing returns while limiting anti-corruption risks.

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Written by:  Kimberly V. Mann

The Security and Exchange Commission’s recent enforcement action against Lawrence D. Polizzotto serves as a reminder to all issuers that Regulation FD enforcement is alive and well.

The Polizzotto Case

Polizzotto, the former vice president of investor relations at First Solar, Inc. (and, ironically, a member of the company’s Disclosure Committee, which is responsible for ensuring the company’s compliance with Regulation FD), was found by the SEC to have violated Section 13(a) of the Exchange Act of 1934 (the “Exchange Act”) and Regulation FD by selectively disclosing material nonpublic information to certain analysts and investors before the information was publicly disclosed.  The selective disclosures were made to reassure certain analysts and investors about the company’s prospects of obtaining two loan guarantees and to correct information that was previously disclosed about another loan guarantee. Polizzotto knew that First Solar had not yet issued a press release containing information about the status of the guarantees, but went forward with the selective disclosures in any event to counter adverse research reports about the company and stem substantial declines in the company’s stock price. The SEC also determined that Polizzotto directed a subordinate to make similar selective disclosures in advance of the public announcement. First Solar did not publicly disclose the information about the guarantees until the morning after the selective disclosures were made and the company’s stock price declined by 6% on the news.

Polizzotto’s selective disclosure caused First Solar to violate Section 13(a) and Regulation FD. Because First Solar provided what the SEC described as “extraordinary cooperation,” and because the company demonstrated a culture of compliance, it was not charged with any violations. The SEC’s order can be found at www.sec.gov/litigation/admin/2013/34-70337.pdf.

Regulation FD Basics

  • Under Regulation FD, an issuer or any person acting on its behalf that intentionally discloses material nonpublic information to (i) broker-dealers or their associated persons, (ii) investment advisers or their associated persons,
    (iii) investment companies or entities such as hedge funds that would be investment companies but for their reliance on exceptions available under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940 or their affiliated persons or (iv) any of the holders of the issuer’s securities, where it is foreseeable that the recipient of the information would purchase or sell the issuer’s securities on the basis of the information disclosed is required to make simultaneous public disclosure of the information. Disclosure is intentional if the disclosing person knows or is reckless in not knowing that the information being disclosed is material and nonpublic.
  • If selective disclosure is unintentional, public disclosure is required to be made promptly following the selective disclosure. Public disclosure is made promptly by a fund if it is made as soon as reasonably practicable after a senior official of the fund or of the fund’s investment adviser learns that there has been unintentional disclosure of material nonpublic information. In no event will public disclosure be deemed promptly made if it is made after the later of (i) 24 hours after the senior official learns of the unintentional disclosure and
    (ii) commencement of trading on the New York Stock Exchange on the trading day after the senior official learns of the unintentional disclosure.
  • In the context of an investment fund, the term “issuer” means a closed-end fund that (i) has a class of securities registered under Section 12 of the Exchange Act (for example, a fund that has more than $10 million in assets and at least 2000 record holders of any class of its equity securities, or has at least 500 record holders of such securities that are not accredited investors) or (ii) is required to file reports under Section 15(d) of the Exchange Act. Open-end and other types of investment companies are not issuers for purposes of Regulation FD. Foreign private issuers also are not subject to Regulation FD.
  • A “person acting on behalf of a closed-end fund” would include a senior official of the fund or of the fund’s investment adviser or any other officer, employee or agent of the fund that regularly communicates with any person to whom selective disclosure of material nonpublic information is prohibited. An agent of a closed-end fund would include a director, officer or employee of the fund’s adviser or another service provider that is acting as an agent of the fund.
  • The requirements of Regulation FD do not apply to disclosures made by a fund  (i) to its attorneys or any other person that owes a duty of trust or confidence to the fund, (ii) to any person that is subject to an obligation to keep the disclosed information confidential, or (iii) in connection with most primary registered offerings of securities under the Securities Act of 1933. The requirements of Regulation FD apply to disclosures made in connection with unregistered private offerings; however, information may be disclosed privately to select recipients if the recipients are bound by a confidentiality agreement.
  • Public disclosure may be made by way of public filings under the Exchange Act, such as on Form 8-K, or by using any other method reasonably designed to provide broad, nonexclusionary public distribution (such as press releases through wire services with wide circulation, news conferences that are open to the public or publication on the issuer’s website).  In 2008, the SEC issued guidance on public disclosure through company websites, which can be found at   http://www.sec.gov/rules/interp/2008/34-58288.pdf.
  • On April 2, 2013, the SEC issued guidance indicating that social media outlets are permitted to be used to disseminate material information publicly in compliance with Regulation FD. The principles outlined in the 2008 guidance on company websites should be used to determine whether a particular social media outlet is an appropriate channel of distribution for purposes of Regulation FD. In order to use a company website or social media to disclose information publicly, investors must be notified of the specific website or social media channel to be used to provide information to the public. The SEC’s investigative report on social media and Regulation FD can be found at http://www.sec.gov/litigation/investreport/34-69279.pdf.

Regulation FD Compliance Measures 

The following is a partial list of measures that funds and their advisers might implement to assist with Regulation FD compliance.

  • Review existing Regulation FD policies with counsel and update them from time to time as appropriate. Indicate in the Regulation FD compliance policy the names and titles of those persons that are authorized to speak to investors on behalf of the fund.
    • Establish procedures for responding to inquiries from investors and market professionals.
    • Develop a definition of “material information” and incorporate it in the Regulation FD policy.
    • Establish procedures for handling one-on-one discussions with investors and market professionals.
    • Develop policies and procedures for the use of a website or social media to disseminate information to the public.
    • Maintain records of prior disclosures of material information.
  • Conduct periodic Regulation FD training for persons acting on behalf of the fund.
  • Conduct periodic Regulation FD compliance audits.
  • Establish accountability for Regulation FD compliance at top management levels.

Establishing effective policies and procedures designed to ensure compliance with Section 13(a) and Regulation FD may, in addition to reducing the risk of violations, have the effect of reducing the risk of liability in the event a violation occurs.

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Written by: Jay B. Gould

On September 23, 2013, the JOBS Act rules that roll back the 80 year old ban on the use of general advertising and public solicitation by issuers of unregistered securities will be a reality. At least it will be a reality for fund managers that do not rely on an exemption from the Commodity Futures Trading Commission. Private funds managers will decide over time whether they would like to avail themselves of the new rules, which will allow them to post performance numbers on their websites, talk openly about their funds on CNBC and Bloomberg, sponsor NASCAR events, and just generally be more open and transparent about their businesses. The responsibilities associated with these new rights are the requirements that the fund manager verify the accredited status of each investor, refrain from committing financial fraud, and file a revised Form D to indicate that the fund is following the new rules. Whether to use these new rules will be a tough call for many fund managers as they consider whether greater transparency provides a benefit for their specific business model. Hedge funds have often avoided the glare of public scrutiny, but the trade-off of building a more recognizable brand and more easily reaching potential investors could provide motivation for some fund managers to give these new rules a try.

But what happens if a fund manager is initially enamored of the new rules and decides to advertise generally, but later changes his mind? Can a fund manager go back to the old “pre-existing, substantial relationship” days, and how do you do that once the fund has been “generally offered” to the public? This could happen for any number of reasons. Perhaps the most prevalent would be that the manager reaches capacity in the fund in either assets, such as a quant fund, or investor slots, which would more likely be the case for a fund that relies on Section 3(c)(1) for its exemption from investment company registration. A fund manager in one of these situations may have originally liked the idea of generally advertising, but subsequently finds public solicitation of limited utility and not worth the potential added scrutiny from regulators and market participants.

If a fund commences an offering pursuant to Rule 506(c) using general solicitation, and later wants to go back and use the old rules, (i.e., rule 506(b)), the issue is one of integration. Rule 506(b) prohibits general solicitation; accordingly, the only way to stop using the public offering rules once a fund manager has done so, would be to wait a period of time so the rule 506(c) offering is not integrated with the rule 506(b) offering. Rule 502(a) of Regulation D provides for a safe harbor from integration so long as the selling effort of the earlier offering ceases for six months, and the fund does not commence a subsequent offering for 6 months after completion of the earlier offering. Therefore, a fund manager would need to cease the offering, file the Form D to indicate that the offering is over, and wait six months before commencing the “private” offering. A new Form D would need to be filed for the private offering under Rule 506(b) once that offering commences.

There is another way whereby fund managers could go straight from the public offering to the private offering without the six month cooling off period. It is possible that a fund manager could use the five factor test safe harbor of Rule 502(a) to avoid integration and commence a new private offering immediately. For most hedge fund managers, this would be fairly tough test to meet. The five factors that a fund would need to consider are as follows:

(a) Whether the sales are part of a single plan of financing;
(b) Whether the sales involve issuance of the same class of securities;
(c) Whether the sales have been made at or about the same time;
(d) Whether the same type of consideration is being received; and
(e) Whether the sales are made for the same general purpose.

In order to meet the requirements of the five factor test, the fund seeking to avoid integration would need to offer a different class of shares/interests, for a different investment purposes, with different terms and conditions. For many hedge fund managers, this will be a difficult standard to meet. So the bottom line here appears to be that you can put Humpty Dumpty back together again, he will just need six months in intensive care.