Category: Fundraising

Make Sure Your Placement Agent is Registered

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The Securities and Exchange Commission cracked down on a fund manager and its placement agent because the placement agent was not registered as a broker-dealer. The federal securities laws require that an individual who solicits investments in return for transaction-based compensation be registered as a broker. There is a fine line between a “finder” and “placement agent.” A line that most fund managers would be best served to stay away from.

An SEC investigation found that William M. Stephens of Hinsdale, Ill., solicited investors as a hired consultant for Ranieri Partners. He was paid fees by the firm, but never registered as a broker. Stephens’ longtime friend Donald W. Phillips, a senior managing director who headed up capital raising efforts for Ranieri Partners, was responsible for overseeing Stephens’ activities. His role supposed to be acting as a “finder” who would merely make initial introductions to potential investors.

Since Stephens was paid a commission on his successful introductions, it looks like he stepped far over the line into the activities of a broker-dealer. He was not supposed to deliver documents or discuss the merits of the fund investment. But he did.

The simple remediation was to only use third party finder, marketing agent, or placement agent that is registered as a broker-dealer. Stephens had to pay a disgorgement of pay disgorgement of $2,418,379.20, the money he earned while acting as unlicensed broker-dealer. Ranieri, the fund manager, was ordered to pay a $375,000 penalty. Stephen’s supervisor was subject to a $75,00 fine and a suspension.

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Seaman Theodore Marion of Philadelphia, PA, uses a bullhorn to instruct a line-handling party in the hangar bay aboard USS Enterprise By U.S. Navy photo by Photographer’s Mate 3rd Class Jason W. Pfiester [Public domain], via Wikimedia Commons.

Looking to Europe

EU-flag

A new regulatory regime is scheduled to impact fundraising in Europe starting this summer. The new regulatory structure known as the Alternative Investment Fund Managers Directive (AIFM) has a July 22 effective regulatory date. The effect will be felt if you are a EU-based fund manager or want to market to EU-based investors.

For U.S.-based managers falling under the AIFM there will be three main requirements:

  1. Disclosure to investors before they decide to invest
  2. Annual report to investors.
  3. Disclosure with regulators.

Even with the approaching deadline, there is still a lot of uncertainty. With EU Directives, it’s up to each member state to decide how to implement it. The UK has announced it will require a fund to register and the Financial Services Authority will have some oversight and will require Form PF-like data. Germany will likely implement a much stricter approach.

The main documents involved are the 2011/61 Directive (.pdf) and the Delegated Regulation (.pdf) that provides additional coverage of some aspects of the Directive. The third is the final report of Guidelines on sound remuneration policies under the AIFMD (.pdf).

If you have EU investors in your U.S.-domiciled fund but you don’t intend to market it anymore in Europe, you probably don’t have to worry about the AIFM directive. However, if you do intend to solicit European investors, you’re probably looking at a July 2014 compliance deadline.

There are some minimal thresholds. For hedge funds, an adviser must manage at least 100 million Euros in assets and for private equity funds the adviser must top a 500 million Euros threshold to fall under the directive. However, member states may reduce these thresholds even lower.

If you have European investors in your US fund or have European operation, the AIFM will start taking up a bunch of your time in the next few months.

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What Happens If You Violate the Ban on General Advertising and Solicitation?

compliance and advertising

I’m not planning to run late night ads for a latest security offering. But what could the Securities and Exchange Commission do about it? Keith Bishop asks: Can the SEC really create illegal actions by its own failures to comply with the law?

Last year’s JOBS Act contained an explicit mandate with an explicit time frame.

 Not later than 90 days after the date of the enactment of this Act, the Securities and Exchange Commission shall revise its rules issued in section 230.506 of title 17, Code of Federal Regulations, to provide that the prohibition against general solicitation or general advertising contained in section 230.502(c) of such title shall not apply to offers and sales of securities made pursuant to section 230.506, provided that all purchasers of the securities are accredited investors.

However, 90 days was never a feasible deadline to draft a rule, make it available for comment, respond to the comments, and publish a final rule. Congress could have made the change a statutory one, leaving the SEC rule explicitly out-of-date. But instead they mandated a regulatory change.

The first question is what would the SEC do to a violator? The SEC has published a JOBS Act page full of Frequently Asked Questions. Under Title III for crowdfunding the SEC published a statement warning would be entrepreneurs that securities crowdfunding is not legal until the regulations are finalized. The FAQ for Title II turns to the Broker-Dealer exemption for advertising. I don’t take the lack of a warning to mean that the SEC won’t prosecute. But given limited resources, you would have to wonder why the SEC would bother.

Assuming the SEC did prosecute, what would the courts do? …

I think I’ve gone on long enough. At this point, your offering is tied up in expensive legal roadblocks and your burning through cash to pay your lawyers. Whatever advantage you thought you might gain from advertising is gone.

Some brave soul may step up and be willing to test the advertising waters out of principle. But it would be a test rooted in sensible economic analysis.

Crowdfunding and the Ban on General Solicitation

18 Rabbits Bars

While entrepreneurs are looking to create crowdfunding portals under Title III of the JOBS Act, small business owners looking to raise capital should keep an eye on the regulatory changes under Title II of the JOBS Act. That may do a better job of opening the spigot for capital than the avalanche of crowdfunding portals likely to appear.

Look at the case of Alison Bailey Vercruysse, a maker of granola-based foods, and her company 18 Rabbits. According to a story in yesterday’s Washington Post, her products attracted a loyal following, but she could not tap those fans for capital as she tried to grow her firm.

“People would come up to me in different places and say: ‘I’m interested in investing in your company. How can I do that?’ ” Vercruysse said. “I couldn’t say we were trying to raise money. I’d end up saying things like; ‘Buy our granola. That would help us.’ ”

Without the ban on general solicitation, the company could put a message on its packaging or its website for accredited investors interested in investing.

Currently, the Securities and Exchange Commission has a ban on the use of general advertising and solicitation for raising private capital under the most popular exemption, Rule 506. Title II of the JOBS Act requires the SEC to remove that ban for offering where all investors are accredited. The agency tried to rush the rules last summer to meet the Congressional deadline, but investor advocates demanded that the SEC slow down. The SEC is gathering public comment before finalizing the rule.

Two SEC commissioners, Dan Gallagher and Troy Paredes, were in favor of immediately lifting the ban. SEC Commissioner Luis Aguilar did not like the rule, saying it lacked adequate investor protections. The fourth SEC Commissioner, Elise Walter voted for the proposal, but expressed concerns. She has stated the SEC must consider ways to mitigate potential harm to investors. The fifth and presumably deciding Commissioner’s seat is vacant with the departure of Mary Shapiro. Looking into my crystal ball, it would seem that the rule is not going to be finalized anytime soon. At least not until the vacancy is filled.

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Crowdfunded Companies Won’t Be Here Anytime Soon

Money

When the JOBS Act passed last spring, there was a huge surge on the future of crowdfunding. In pursuit of the riches of startup investing, many ignored the already successful world of Kickstarter, Indie Go Go, and others that already successfully fund projects. Those platforms don’t show the investor a pot of gold at the end of the rainbow. They show the investor the final project and maybe the chance to purchase one or participate.

By switching to equity fundraising, the focus would switch to the potential financial reward and perhaps less on the value of the project. Critics wailed about the onslaught of fraud. Proponents praised the unleashing of entrepreneurial capital. The lawyers and regulators worried about how to implement this new capital raising regime.

Congress didn’t make it easy. They chose do throw out the original crowdfunding law proposed for the JOBS Act and replaced it with a very cumbersome and difficult new piece of legislation. They gave the Securities and Exchange Commission 270 days to come out with the regulations. That’s on top of the huge pile of regulatory mandates passed 2 years ago with Dodd-Frank.

We have seen no inkling that the SEC has come close to proposed regulations. With the departure of Mary Shapiro, the SEC is down to four commissioners. Two of whom have publicly voiced their concerns about crowdfunding. Even if the SEC can gather three out of four of the commissioners to agree on proposed regulations, there will be a lengthy comment period and likely re-writing to get to the final regulations.

In addition to the SEC, FINRA will need to create a regulatory regime for the registration of crowdfunding portals. To get a taste of how difficult this going to be, you can take a look at the first baby steps of regulatory work that came from FINRA.

FINRA is inviting prospective crowdfunding portals to voluntarily file an interim funding portal form. The filing is meant to help FINRA develop rules that reflect the funding portal community and its business. It is not an application and does not get anyone any closer to having a working equity crowdfunding platform.

For a taste of the difficulties take a look at the last question:

Please describe how the [Funding Portal] addresses the requirements for funding portals under the JOBS Act. In particular, please describe how the [Funding Portal] would
(i) address investor education;
(ii) take measures to reduce the risk of fraud with respect to funding portal transactions;
(iii) ensure adherence to the aggregate selling limits; and
(iv) protect the privacy of information collected from investors.

The successful crowfunding portals are going to have to master difficult regulations, successfully court attractive investment opportunities, master the 50 states of privacy legislation, come up with effective investor eduction tools, and successfully attract investors willing to write checks.

I still think crowdfunding will end up being a minor league system for the investment banks. They have the resources to conquer these hurdles. They can use the database of investors to mine for more conventional investment opportunities. They can use the few successful crowdfunded companies to sell bigger opportunities for raising more capital. It seems to me that we are still many, many months away from seeing the first crowdfunding portal under the JOBS Act.

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Private Placement of Fund Interests and Rule 5123 Filings

Under the new FINRA rule 5123, FINRA member firms that sell securities in certain private placements to submit a notice filing with FINRA.  That means your placement will likely have to file a fund’s private placement memorandum with FINRA. FINRA recently released FAQs and a user guide related to Rule 5123 filings. The notice filing must include a copy of any private placement memorandum, term sheet or other offering document, including any materially amended versions thereof, used in connection with such sale.

Submissions must be made within 15 calendar days of the first sale.

The FAQs answer practical questions regarding filing requirements, such as:

  • how members file a notice with FINRA
  • when does the 15-day period commence for filing with FINRA
  • What exemptions are there to form Rule 5123

Exemptions

1. Are private placements sold to institutional accounts exempt from the filing requirements of Rule 5123?

Private placements sold solely to institutional accounts (as defined in Rule 4512(c)) are exempt from the filing requirements of the rule (see Rule 5123(b)(1)(A)).

2. Are private placements sold to accredited investors exempt from the filing requirements of Rule 5123?

No, unless the sales are solely to entities that satisfy the definition of accredited investor under Rule 501(b)(1), (2), (3), or (7). Sales to accredited investors that are natural persons are not exempt from the filing requirements of the rule (see Rule 5123(b)(1)(J)).

If your fund uses a placement agent and is marketing to high-net worth individuals, it looks like the marketing materials will end up being filed with FINRA.

Filing Private Fund Private Placement Memoranda with FINRA

Starting on December 3, 2012, FINRA members must file a copy of any private placement memorandum, term sheet or other offering document the firm used within 15 calendar days of the date of the sale. Placement agents for private funds will likely be FINRA members and subject to this rule.

FINRA Rule 5123 is part of FINRA’s approach to increase oversight and investor protection in private placements. FINRA established standards on disclosure, use of proceeds and a filing requirement for private placements issued by a member firm or a control entity in Rule 5122. FINRA also has previously provided guidance on the scope of a firm’s responsibility to conduct a reasonable investigation of private placement issuers in Regulatory Notice 10-22.

However, the rule has some big exemptions. The following private placements are exempt from the requirements of this Rule:

(1) offerings sold by the member or person associated with the member solely
to any one or more of the following:

(A) institutional accounts, as defined in Rule 4512(c);
(B) qualified purchasers, as defined in Section 2(a)(51)(A) of the Investment Company Act;
(C) qualified institutional buyers, as defined in Securities Act Rule 144A;
(D) investment companies, as defined in Section 3 of the Investment Company Act;
(E) an entity composed exclusively of qualified institutional buyers, as defined in Securities Act Rule 144A;
(F) banks, as defined in Section 3(a)(2) of the Securities Act;
(G) employees and affiliates, as defined in Rule 5121, of the issuer;
(H) knowledgeable employees as defined in Investment Company Act Rule 3c-5;
(I) eligible contract participants, as defined in Section 3(a)(65) of the Exchange Act; and
(J) accredited investors described in Securities Act Rule 501(a)(1), (2), (3) or (7).

That list is likely going to mean that private fund offering will not be subject to the rule as long as they exclude non-accredited investors from the offering. Or at least exclude the placement agent from soliciting non-accredited investors. Given the likely lifting of the ban on general solicitation for private funds that exclude non-accredited investors this rule is likely to further limit the access of non-accredited investors to private funds.

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SEC Brings a Pay-to-Play Action

The Securities and Exchange Commission filed a “pay-to-play” case against Goldman Sachs and one of its former investment bankers, Neil M.M. Morrison. The SEC alleges that Goldman and Morrison made undisclosed campaign contributions to then-Massachusetts state treasurer Timothy P. Cahill while he was a candidate for governor.

The case was brought under the Municipal Securities Rule on pay-to-play: MSRB Rule G-37. The SEC’s investment adviser/private fund rule on pay to play, Rule 206(4)-5, is based closely on that MSRB rule.

The SEC’s order found that Goldman Sachs did not disclose any of the contributions on MSRB forms and did not  keep records of the contributions in violation of MSRB rules.

Goldman Sachs agreed to settle the charges by paying $7,558,942 in disgorgement, $670,033 in prejudgment interest, and a $3.75 million penalty. This is the largest fine ever imposed by the SEC for Municipal Securities Rulemaking Board pay-to-play violations. The SEC’s case against Morrison continues.

According to the SEC’s order against Goldman Sachs, Morrison worked in the firm’s Boston office and solicited underwriting business from the Massachusetts treasurer’s office beginning in July 2008. Morrison was substantially engaged in working on Cahill’s political campaigns. Before joining Goldman Sachs, between January 2003 and June 2007, Morrison was employed by the Massachusetts Treasurer’s Office, which included positions as the first deputy treasurer, chief of staff and assistant treasurer, reporting directly to Cahill.

Morrison participated extensively in Cahill’s gubernatorial campaign, often during working hours from his Goldman Sachs office, and used Goldman Sachs resources (such as phones, e-mail and office space). The SEC claims that Morrison’s use of Goldman Sachs work time and resources for campaign activities constituted valuable in-kind campaign contributions to Cahill that were attributable to Goldman Sachs and disqualified the firm from engaging in municipal underwriting business with certain Massachusetts municipal issuers for two years after the contributions.

While Morrison was an employee and working on the Cahill campaign, Goldman Sachs participated in 30 prohibited underwritings with Massachusetts issuers and earned more than $7.5 million in underwriting fees.

According to the complaint, this seems like an egregious violation of the pay-to-play rules. It does highlight that items beyond cash contributions could be considered a “contribution” under the pay-to-play rule.

We would not consider a donation of time by an individual to be a contribution, provided the adviser has not solicited the individual’s efforts and the adviser’s resources, such as office space and telephones, are not used….

A covered associate’s donation of his or her time generally would not be viewed as a contribution if such volunteering were to occur during non-work hours, if the covered associate were using vacation time, or if the adviser is not otherwise paying the employee’s salary

Sec Release IA-3403 page 46 and footnote 157 (.pdf)

From a compliance perspective, the question is how to value the use of time in the office, email, and phone usage. I suppose you can add up long distance charges. For employees you can use their hourly rate to determine time spent.  For Morrison, it appears that even using a very conservative measurement  of his time and the Goldman resources, the value would be many times in excess of the $250 limit under the MSRB rule. (The SEC limit is $350 if you can vote for the person.)

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Senate Races and SEC Limits on Political Contributions

Last year a new rule from the Securities and Exchange Commission went into effect that limited the ability of investment advisers and private fund managers to make political campaign contributions. The purpose was to prevent some illicit pay-to-play activity by government officials who control government sponsored investment funds. With the close of the national political conventions and selection of the Republican and Democratic tickets, it’s clear how the pay-to-play rule for investment advisers will affect the presidential fund-raising.

It won’t.

Let’s take a look at Congress and see how  Rule 206(4)-5 affects campaign contributions for some of the currently competitive Senate races.

Connecticut

Chris Murphy is currently a member of the US House of Representatives. Therefore, donations to him would not be limited by the rule.

Linda McMahon does not currently hold a political office. She was the former CEO of World Wrestling Entertainment. Therefore, donations to her would not be limited by the rule.

Indiana

Joe Donnelly is a member of the U.S. House of Representatives. Therefore, donations to him would not be limited by the rule.

Richard Mourdock is the current  State Treasurer of Indiana. That position raises a red flag and requires further research. The Treasurer or his nominee serves on the Board of Trustees of the Indiana Public Retirement System, the state’s largest pension system. If your firm want access to those government investment funds, you will need to limit donations to Mr. Mourdock.

Massachusetts

Scott Brown is the incumbent Senator. Therefore, donations to Mr. Brown would not be limited by the rule.

Elizabeth Warren is a professor at Harvard and does not currently hold a political office. Therefore, donations to her would not be limited by the rule.

Missouri

Claire McCaskill is the incumbent Senator. Therefore, donations to her would not be limited by the rule.

Todd Akin is a Republican member of the United States House of Representatives. Therefore, donations to him would not be limited by the rule.

Montana

Jon Tester is the incumbent Senator seeking reelection. Therefore, donations to him would not be limited by the rule.

Denny Rehberg is currently a member of the US House of Representatives. Therefore, donations to him would not be limited by the rule.

Nevada

Shelley Berkley is a member of the United States House of Representatives. Therefore, donations to her would not be limited by the rule.

Dean Heller is the incumbent Senator. Therefore, donations to him would not be limited by the rule.

North Dakota

Heidi Heitkamp is a former Attorney General, but does not currently hold a political office. Therefore, donations to her would not be limited by the rule.

Rick Berg is a member of the United States House of Representatives. Therefore, donations to him would not be limited by the rule.

Ohio

Sherrod Brown is the incumbent Senator. Therefore, donations to Mr. Brown would not be limited by the rule.

Josh Mandel is the current Treasurer of Ohio. Donations to Mr. Mandel are limited by the rule. The Treasurer appoints members to the state retirement system boards who select investment and investment advisers.

Virginia

Tim Kaine is a former Governor of Virginia. Therefore, donations to him would not be subject to the rule. If he was still the sitting governor, donations to him would have been limited.

George Allen is also a former Governor of Virginia and was a former US Senator from Virginia. Therefore, donations to him would not be subject to the rule. If he was still the sitting governor, donations to him would have been limited.

Wisconsin

Tammy Baldwin is currently a member of the US House of Representatives. Therefore, donations to her would not be limited by the rule.

Tommy Thompson was a former governor of Wisconsin, but does not currently hold a political office. Therefore, donations to him would not be subject to the rule. If he was still the sitting governor, donations to him would have been limited.

Also keep in mind that contributions to state and local political parties are also limited by the rule.

Even if the contributions to a particular candidate are not limited by the rule, an investment adviser is still required to keep a record of all campaign contributions.

Senate Map is from Real Clear Politics

The Vice President and SEC’s Pay to Play Rule

Now that the Democratic and Republican conventions have ended and the presidential tickets are final, we can look at how the SEC’s new rule on political contributions will affect the November election. It won’t.

Early in the Republican contest for the nomination, Rick Perry was on the watch list under Rule 206(4)-5. Since he could directly or indirectly control several state pension funds in the State of Texas, contributions to Governor Perry would be subject to the rule. That means limiting contributions to $350.

It’s clear how the rule worked for Presidential nominees. It was not clear to me how the rule would work with the vice presidential candidates. The office itself does not control a government pension fund. But you need to look to the candidates current office as well under the Rule.

If Mr. Romney had selected a sitting governor, such as New Jersey’s Chris Christie, the SEC rule would have limited political contributions to the Republican ticket. In most states, Governors appoint board members for the state pension funds. It’s not clear whether that nomination would have tainted past contributions to the Republican campaign.

With Mitt Romney’s selection of Paul Ryan as his vice presidential running mate, we don’t have to look for the answer yet. Mr. Ryan is an incumbent U.S. Congressman and is not associated with selecting advisers or investments for a government pension fund.

Based on a quick glance of the other tickets, it looks like the pay-to-play rule does not apply to most of the other political parties looking to grab a few votes in November.

The Libertarian Party is on the ballot in most states. It’s candidates Former Governor Gary Johnson (New Mexico) and
Former Superior Court Judge Jim Gray (California) do not currently hold political office.

The Green Party weaved its way through the ballot process and managed to get on the ballot in about half of the states. Neither Dr. Jill Stein (Massachusetts) nor Cheri Honkala (Pennsylvania) currently hold political office.

I’m a bit confused by the ballot of the Party of Socialism and Liberation. Their presidential candidate, Peta Lindsay, and their vice presidential candidate, Yari Osorio, are both under the Constitution’s mandated minimum age for their respective offices. In addition Mr Osorio is foreign born, making him further ineligible to hold the office.

I have no comment on Rosanne Barr’s presidential campaign.