This February 2022 Client Alert summarizes certain key U.S. federal securities laws that non-U.S. advisers should consider before offering equity interests in non-US private investment funds in the United States.

Securities Act of 1933

The U.S. Securities Act of 1933 (the “Securities Act”) requires every offer and sale of securities made using U.S. means of interstate commerce to be registered with the U.S. Securities and Exchange Commission (the “SEC”), unless an exemption from registration applies.  To avoid registering their interests, private funds typically rely on the private placement exemption in Section 4(a)(2) of the Securities Act and the safe harbor from registration provided by Rule 506 of Regulation D.  Rule 506 permits an issuer to raise an unlimited amount of capital from an unlimited number of “accredited investors,”[1] provided that the issuer complies with the other requirements of Regulation D.  There are two types of Regulation D offerings available to private funds as follows:

Rule 506(b) Private Placement

Rule 506(b) is available to private offerings that do not involve any “general solicitation” or “general advertising” by the private fund, or any person acting on behalf of the fund or the funds’ sponsor, with respect to the offer or sale of securities in a Regulation D offering. 

Prior to contacting a potential investor in the United States, the adviser to a private fund (or a person acting on the adviser’s behalf) should have a pre-existing substantive relationship with the investor, which can be personal or professional, and a reasonable good faith belief that the potential investor is accredited.  There are no limits on the number of offerees.  Private funds typically identify the name and pre-existing relationship with each recipient of the fund’s offering materials.  The pre-existing requirement means that sufficient time must pass after the relationship is formed, before the offering of the fund’s interests.  General solicitation is not limited to news articles or internet solicitation.  For example, general solicitation or advertising could be implied if a fund’s offering materials are available through a web site that is not password-protected, or if a fund’s offering materials are circulated broadly to attendees of a seminar[2] or members of a club or other organization (even if all attendees or members likely are accredited investors) or if a fund adviser is interviewed about the fund for a newspaper article during the fund’s offering period.

Rule 506(c) General Solicitation or General Advertising

Rule 506(c) permits offers and sales to be made using general solicitation, provided that all investors are “accredited investors” and the private fund’s sponsor takes reasonable steps to verify their accredited investor status.   For this safe harbor, investors cannot simply self-certify that they are accredited.  Instead, the private fund’s sponsor must undertake a “principles-based approach” for determining accredited investor status, such as requesting and reviewing the investors’ tax returns, or bank or brokerage account statements, or requiring the investor to submit a “third party verification form,” where the investor’s financial, legal or tax adviser confirms in writing that the investor is accredited.[3]

Additional Requirements for Relying on Rule 506

Regulation D imposes a number of requirements that apply to both Rule 506(b) and Rule 506(c) offerings.  These include:

1. “Bad Actor” Provisions – The “bad actor” provisions of Rule 506(d) apply if either the issuer or any of its covered persons have been subject to certain disqualifying events. Disqualifying events occurring on or after September 23, 2013 will disqualify the issuer from relying on Rule 506, while earlier events will trigger only an obligation to disclose the disqualifying events to purchasers. 

• Persons Covered by Rule 506(b) – Persons covered by Rule 506(d)—e., the bad acts of which will generally trigger disqualification or disclosure—include:
  • the private fund issuer, its predecessors and affiliated issuers;[4]
  • executive officers, general partners, directors, and managing members of the issuer;
  • other officers of the issuer who are participating in the offering;
  • persons beneficially owning 20% more of the issuer, calculated on the basis of voting power;
  • promoters connected to the issuer;
  • for pooled investment funds, the investment manager and its principals; and
  • persons compensated for soliciting investors for the issuer (such as placement agents), including their directors, general partners and managing members.
• Disqualifying Events – Rule 506(d) provides a list of disqualifying events, which generally include felony or misdemeanor convictions and regulatory orders in connection with securities transactions, false SEC filings, or otherwise arising out of conduct of certain financial intermediaries. Important here, disqualification under Rule 506(d) is not triggered by actions taken in jurisdictions other than the United States, such as convictions by a non-U.S. court and regulatory orders issued by non-U.S. regulatory authorities.[5] 

2. Limitations on Resale of Securities – Securities purchased in a Rule 506 exempted offering cannot be resold by the investor without registration under the Securities Act or an applicable registration exemption. Rule 502(d) requires the issuer to take “reasonable care”[6] to ensure that purchasers of its securities in a Rule 506 offering are not “underwriters”—e., they are not purchasing the securities with a view to distribute the securities. 

These resale limitations do not apply to an issuer’s redemption of its own securities.  In addition, limited private transfers or sales of securities obtained in a Rule 506 offering are generally permissible.  The main policy behind the resale restrictions is to prevent issuers from circumventing the Securities Act’s registration requirements through an initial private sale of securities under Rule 506 followed by a public resale of those securities by the acquirer. 

3. Notice of Sale: Form D – An issuer of securities must file with the SEC a notice on Form D no later than 15 days after the first sale of its securities in a Regulation D offering.[7] Form D requires disclosure of fairly basic information regarding the issuer and the securities offering, although certain of this information may be considered sensitive, such as the total dollar amount of securities sold in the offering, the identities of finders compensated to solicit investors, and the total amount of compensation paid to finders.  Form D must be amended annually during the offering period, on or before the anniversary of the most recently filed Form D. 

US Investment Company Act

 The US Investment Company Act of 1940, as amended (the “Investment Company Act”) regulates “investment companies” that hold themselves out as investing in “securities,” which are broadly defined to include all securities other than securities of majority-owned subsidiaries, U.S. Government securities and cash. 

Private investment funds typically rely on one of the following exemptions:

Section 3(c)(1) is available to a private fund if its outstanding equity securities are owned by than 100 beneficial owners.  We note that a private fund can be required to “look through” and count investors in private entities that own its shares under certain circumstances.

Section 3(c)(5) – we note that private funds that exclusively own fee simple interests in real estate would be not investment companies.  To the extent that a private real estate fund holds securities, including partial or JV interests in property companies that it does not control, the fund typically relies on 3(c)(5), which exempts any private real estate or real estate debt fund that holds at least 80% of its assets in be fee simple interests in real estate or real estate mortgages that are secured by real estate, and certain other real estate-related assets; provided that the fund does not issue redeemable securities. 

Section 3(c)(7) is available to a private fund that is owned exclusively by “qualified purchasers.”  Qualified purchasers include natural persons and family offices that own not less than US$5 million of investments, or entities that own and invest on a discretionary basis not less than US $25 million of investments.

Application to US Investors Only.  We note that a private fund formed in a non-US jurisdiction that maintains its principal place of business outside of the United States is generally not required to analyze the status of investors residing outside of the United States for purposes of the Investment Company Act, and only the US investors of such funds need to be taken into account for purposes of the Investment Company Act.

For purposes of determining the 100 beneficial owner threshold under 3(c)(1), a non-U.S. company need only count U.S. person investors towards the 100 investor limit.[8]  Similarly, a non-U.S. company relying on Section 3(c)(7) need only require that its U.S. person investors are “qualified purchasers.”[9] 

US Investment Advisers Act 

The U.S. Investment Advisers Act of 1940, as amended (the “Advisers Act”) regulates investment advisers that have a place of business in the United States or that provide investment advice to US persons (directly or indirectly as investors in private funds managed by the adviser).  An “investment adviser’ is defined as any person who, for compensation, engaged in the business of advising others as to the value of securities or the he advisability of investing, purchasing or selling securities. 

 If a private fund sponsor engages in fundraising activities in the United States and counts US persons among its investors, the fund’s sponsor will be subject to the Advisers Act and will be required to register (or find an exemption from registration).

 The Advisers Act provides exemptions from registration for (i) private fund advisers; (ii) advisers to venture capital funds (e.g., funds that hold themselves out as pursuing a venture capital strategy and that invest at least 80% of their assets in equity interests acquired directly from private companies; and (iii) foreign private advisers with no place of business in the United States and less than 15 private fund investors with less than $25 million in capital commitments to the private fund.   

 In general, a foreign adviser will be an exempt private fund adviser if (a) the adviser has no clients that are US persons other than private funds and (b) all assets managed by the adviser from a place of business in the United States are solely attributable to private funds, the total value of which is less than $150 million. 

We note that private fund advisers and venture capital fund advisers typically are required to file SEC Form ADV as an “exempt reporting” adviser via the IARD system.

Disclosures of Performance and Marketing Claims

Even if a foreign adviser is not required to register with the SEC as an investment adviser that is subject to the Advisers Act, the SEC continues to have jurisdiction to take enforcement action with respect to any false and misleading advertising or marketing claims in connection with the offer and sale of securities in the United States.  

On January 27, 2022, the SEC’s Division of Examinations published a “Risk Alert” based on the staff’s observations related to false and misleading marketing claims by private fund advisers, as well as the advisers’ failure to maintain all  accounts, books, internal working papers, and any other records or documents that are necessary to form the basis for or demonstrate the calculation of any performance or rate of return included in marketing materials.

• Misleading information about a track record. The Staff noted that certain private fund advisers marketed inaccurate or misleading disclosures about their track record, including how benchmarks were used or how the portfolio for the track record was constructed. For example, the staff observed advisers that only marketed a favorable or cherry-picked track record of one fund (or a subset of funds), or did not disclose material information about the impact of leverage on fund performance. In addition, the staff observed private fund advisers that utilized stale performance information in presentations to potential investors or track records that did not accurately reflect the fund’s fees and expenses.
• Inaccurate performance calculations. The SEC staff observed private fund advisers that presented inaccurate performance calculations to investors. For example, the staff observed private fund advisers that used inaccurate underlying data (e.g., data from incorrect time periods, mischaracterization of return of capital distributions as dividends from portfolio companies, and/or projected rather than actual performance used in performance calculations) when creating track records, thereby leading to inaccurate and potentially misleading disclosures regarding performance.
• Portability - failure to support adequately, or omissions of material information about, predecessor performance. The staff observed private fund advisers that did not maintain books and records supporting predecessor performance at other advisory firms as required under the Advisers Act. In addition, the staff observed private fund advisers that appeared to have omitted material facts about predecessor performance. For example, the staff observed private fund advisers that marketed incomplete prior track records or advertised performance for portfolio managers at the adviser who were not primarily responsible for achieving those results at their prior advisory firm.
• Misleading statements regarding awards or other claims. The SEC staff observed private fund advisers that made misleading statements regarding awards they received or characteristics of their firm. For example, the staff observed private fund advisers that marketed awards received, but failed to make full and fair disclosures about the awards, such as the criteria for obtaining them, the amount of any fee paid by the adviser to receive them, and any amounts paid to the grantor of the awards for the adviser’s right to promote its receipt of the awards. The staff also observed advisers that incorrectly claimed their investments were “supported” or “overseen” by the SEC.

We note that the SEC has adopted significant revisions to Advisers Act Rule 206(4)-1 that address the marketing of private funds. The rule, which advisers must comply with by November 4, 2022, provides additional specificity regarding misleading marketing materials.

Side-by-Side US and Non-US Offerings

Private funds may make a “global” offering, where the sponsor restricts all investors in the offering, regardless of where they are located, to the requirements under SEC Regulation D and the Investment Company Act exemptions described above. 

However, a foreign private adviser may not wish to impose these U.S. qualifications and restrictions on foreign investors. These sponsors may elect to conduct a “side-by-side” offerings, with one offering to US investors under SEC Regulation D and another offering offshore to non-US investors under SEC Regulation S.

A. Regulation S

Regulation S provides that the Securities Act’s registration requirements “shall be deemed not to include offers and sales that occur outside the United States.”  Regulation S also provides a number of non-exclusive safe harbors for different categories of securities sales.  A sale of securities satisfying a Regulation S safe harbor will be deemed to occur “outside the United States,” thus exempting the securities from Securities Act registration. 

The Regulation S safe harbors are not exclusive.  There is also no presumption that a non-U.S. securities offering is subject to Securities Act registration just because the offering fails to meet the terms of a Regulation S safe harbor.  Securities Act Rule 152(b)(2) provides that offers and sales in compliance with .Regulation S will not be integrated with other offerings.

B. Avoiding Integration of Side-by-Side Regulation S and Regulation D Offerings

The SEC’s integration doctrine “seeks to prevent an issuer from improperly avoiding registration [under the Securities Act] by artificially dividing a single offering into multiple offerings such that Securities Act exemptions would apply to the multiple offerings that would not be available for the combined offering.”[10]  The SEC has stated, however, that “[o]ffshore transactions made in in compliance with Regulation S will not be integrated with . . . domestic offerings that satisfy the requirements for an exemption from registration under the Securities Act.”  

For private fund sponsors, this means that the fund’s non-U.S. offering should comply with Regulation S while its U.S. offering should comply with Regulation D, and that these be two distinct offerings.  To keep these as distinct offerings, we recommend at least the following:

• Separate and distinct offering materials for the U.S. and Non-U.S. offerings. The materials can be substantially the same, but need to reflect the differences in laws between a U.S. offering and non-U.S. offering, including application of US tax laws and Securities Act or Investment Company Act certifications needed with respect to that offering, for example. 
• Separate websites for the U.S. and the non-U.S. offerings. S. persons should not be permitted to access or invest through the web site for the non-U.S. offering.
• Consider a general ban on public solicitation. Although Regulation S has no ban on general solicitation or advertising, advertisements and offering materials broadly distributed outside the United States with respect to the Regulation S offering could find their way into, or otherwise be accessible from, the United States, potentially being deemed “directed selling efforts” in the United States and preventing a private fund from relying on the Regulation S safe harbor.

[1] “Accredited investors” generally include natural persons with a net worth (including joint net worth with spouse) with a net worth exceeding $1,000,000 (excluding primary residence equity), natural persons with individual incomes exceeding $200,000 (or $300,000 jointly with spouse), and organizations with total assets in excess of $5,000,000. 

[2]  In new SEC rule effective March 15, 2021 (https://www.sec.gov/rules/final/2020/33-10884.pdf) (“New Rule 148”), communications at a “demo day” may not be considered to constitute general solicitation if certain criteria are met.

[3]  In New Rule 148, the SEC attempted to relax the investor verification requirements so that an investor’s accredited investor status need be verified by the issuer once every 5 years.  The SEC also attempted to signal that issuers need not rely solely on the stated safe harbors to verify an investor’s accredited investor status.

[4] The SEC staff interprets “affiliated issuer” as an affiliate (as defined in Rule 501(b) of Regulation D) of the issuer that is issuing securities in the same offering, including offerings subject to integration under Rule 502(a) of Regulation D.  See Securities Act Rules Compliance and Disclosure Interpretations, Q&A 260.16; available at https://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm (“Compliance Interpretations FAQ”). 

[5] Compliance Interpretations FAQ, Q&A 260.20. 

[6] “Reasonable care” can be established through taking steps such as: (i) obtaining written certifications from each buyer at the initial placement that, among other things, the buyer is acquiring the security for its own account (or for accounts over which it exercises investment discretion), and not with a view to distribute the securities; (ii) written disclosure to each purchaser prior to the sale that the securities have not been registered under the Securities Act and describing the restrictions on transferability and resale of the securities; and (iii) placing a legend on the security certificate (if certificated) or other document that evidences the securities stating that the securities have not been registered under the Securities Act and describing the restrictions on transferability. 

[7] Securities Act Rule 503(a).  A “sale” for these purposes is the date “on which the first investor is irrevocably contractually committed to invest, which, depending on the terms and conditions of the contract, could be the date on which the issuer receives the investor's subscription agreement or check.”  Compliance Interpretations FAQ 257.04. 

[8] See, e.g., Goodwin, Proctor & Hoar, SEC No-Action Letter (Oct. 5, 1998); Wilmer, Cutler & Pickering, Davis Polk & Wardell, SEC No-Action Letter (Oct. 5, 1998); Global Mutual Fund Survey, SEC No-Action Letter (July 14, 1992; Goodwin, Proctor & Hoar, SEC No-Action Letter (Feb. 28, 1997).   

[9] Id. 

[10] Securities Act Release 10884 (Nov. 2, 2020); available at https://www.sec.gov/rules/final/2020/33-10844.pdf (“Release 10884”). 

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