IR regulation concerns

Raj Marphatia and Susan Eisenberg of Ropes & Gray provide an overview of legal and regulatory considerations for investor relations professionals

Private equity funds and their sponsors are subject to a variety of laws and regulations that affect their operations and that impose material compliance costs. This chapter provides a broad overview of such laws and regulations from the perspective of an investor relations professional, with a particular focus on US federal law. Part I of this chapter outlines the rules governing the fundraising process. Part II discusses the laws that regulate the fund as an investment company. Part III summarises the legal requirements that apply to investment advisers such as the manager of a private equity fund. Finally, Part IV notes statutes that affect the fund’s ongoing operations and that directly impact investors in a private equity fund. Since this guide is targeted to a non-legal audience, this chapter is a broad overview that minimises legal citations and is not intended to comprehensively describe all relevant laws and regulations and their nuances. Readers seeking answers to specific legal questions are urged to consult a lawyer.

Interests in private equity funds are widely recognised to be securities, and hence the offering of interests in a fund is heavily regulated by federal, state and non-US securities laws. In general, a securities offering will be governed by the laws of the jurisdiction in which the offerees are located, the sponsor is located or the fund is domiciled. Thus, a fund that solicits investors in the US and in Canada will be required to comply with the securities laws of the US and those of Canada, as well as the securities laws of the jurisdiction where the sponsor is located and the fund is domiciled. This section focuses on the Securities Act and the Exchange Act.

The Securities Act is the primary US federal law governing the offering and sale of securities. It requires a private investment fund issuing securities to file a registration statement with respect to those securities with the US Securities and Exchange Commission (SEC), or avail itself of an exemption from the registration requirement.

Registered securities offerings are expensive and time-consuming. Fund sponsors almost always avoid registered offerings by typically relying on one of three exemptions from registration: the Section 4(2) private placement exemption, Regulation D or Regulation S.

Section 4(2) of the Securities Act provides an exemption from registration for transactions by an issuer ‘not involving any public offering’. The term ‘public offering’ is not defined in the Securities Act, but this exemption (often referred to as the ‘private placement exemption’) has been interpreted to require an offering to only a limited number of sophisticated investors who have access to the kind of information that would ordinarily be contained in a registration statement. These requirements are very subjective. There is no clear guidance on the required level of sophistication and there is no ceiling on the number of offerees or purchasers in a Section 4(2) private placement.

Given these ambiguities, although offerings of interests in private equity funds should fit within the Section 4(2) requirements, most sponsors prefer to rely on Regulation D or Regulation S, which provide more certainty with regard to exemption from registration. As a result, the Section 4(2) exemption is today typically regarded as a fallback when other exemptions are unavailable.

Regulation D is a non-exclusive safe harbour promulgated by the SEC to provide greater certainty to issuers seeking to avoid registration. An offering that satisfies the requirements of Regulation D is exempt from registration under the Securities Act (note that because the safe harbour is non-exclusive, an offering that fails to satisfy the Regulation D requirements may still qualify as a private placement under Section 4(2)).

Regulation D actually consists of three alternative safe harbours under Securities Act Rules 504, 505 and 506, but because Rules 504 and 505 cap the dollar amount that may be raised in the private offering to $1 million and $5 million, respectively, funds most commonly rely on Rule 506, which has no limit on the size of the offering.

This partial chapter is one of 19 in The Investor Relations Manual: Creating and maintaining best-in-class private equity GP-LP relationships, a new book from PEI Media.