What is a private equity fund, and what makes "PE" funds different from other funds? Who can invest, and what are the key securities laws exemptions?
Jeff Tabak is a long-time private funds lawyer and a regular lecturer on topics relating to private equity.
Private equity funds have played a significant role in the economy for some time now. What makes a private equity fund different from other funds that own mutual funds or other stocks? Hi, I'm Jeff Tabak, and I'm going to talk a little bit about what makes private funds different. Bear in mind that a lot of what we're going to talk about is going to be general in nature. So there are some nuances and other differences that we're not going to go into detail about today.
One of the major statutes that you have deal with when you’re offering and selling securities is the Securities Act of 1933. But when you're raising a private equity fund, you don't have to worry about registering with the SEC. So there's actually exemption from registering under the 33 Act for private placements for private equity funds.
So how does a private equity fund avoid having to register? Well, what it relies upon is a safe harbor under the 33 Act that we call "Regulation D." In order to satisfy the safe harbor, the investors will need to satisfy certain requirements.
Most private equity funds offer their securities only to "accredited investors." That's a defined term under the '33 Act, but it includes (a) individuals with net worths of at least $1 million, excluding their primary residence, or (b) income of at least $200 thousand a year or $300 thousand with their spouse for the last two years with a reasonable expectation of that same income in the current year, or (c) entities with at least $5 million of net worth.
Also, the issuer cannot engage in a general solicitation. What I tell clients is that means they can't go into Central Park and suddenly distribute their private placement memorandum to anyone who walks by who might be interested in their fund.
Another statute that governs private equity funds is the Investment Company Act of 1940. Private equity funds rely on two exceptions in order to avoid registration. One is called section 3(c)(1) and the other one is section 3(c)(7). Let’s talk about 3(c)(1) first. Under section 3(c)(1), the investment company has to have not more than 100 beneficial owners in order to qualify for that exception. Under 3(c)(7), the issuer can sell only to what are called "qualified purchasers." A qualified purchaser is an individual with at least $5 million of investment assets or an entity with at least $25 million of investment assets. That makes the group of investors who are eligible to participate pretty limited.
The last relevant statute for raising a private equity fund is the Investment Advisers Act of 1940. That governs the registration of investment advisors. Before the financial crisis, managers were generally exempt from registering. But since Dodd Frank and the financial crisis, most large managers have to register with the SEC as an investment advisor.
We used to tell managers that it really wasn't a big deal. They just had to file a form and go about their business. But what's happened is that investment advisors now have to have very strict compliance policies and procedures, and the SEC has now come in on a regular basis to examine many private equity fund managers. This has led to an increased amount of enforcement actions by the SEC over the course of the last few years, and has cost fund managers a significant amount of money. That's a big change over the way private equity funds used to operate.
So what makes private equity funds different from other investment vehicles? They are still exempt from the '33 Act, they are still exempt from the '40 Act, but now managers have to pay attention to the Advisers Act of 1940.
I'm Jeff Tabak. Thanks for watching TalksOnLaw.