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Private Funds, the SEC, and the Law: Which Rules Apply?

A private fund manager discussing SEC compliance

A private fund refers to an entity that consolidates funds from numerous investors without actively seeking public investment. While these funds are not mandated to be treated as investment companies, it is important to note that they are still subject to SEC oversight and must adhere to significant federal regulations. If you have an interest in establishing and managing a private fund, it is crucial to seek legal counsel to ensure compliance with these rules. My RIA Lawyer is available to guide you through this process.

Which Laws Apply to the Private Fund Itself?

Private funds do not have to be registered or regulated as investment companies under federal securities laws. However, a private fund cannot publicly offer its securities. Also, federal securities laws contain broad anti-fraud provisions that apply to all funds and advisers. This is even though they may not otherwise be subject to said laws.

Private funds can be exempt from the Investment Company Act of 1940 if they meet certain criteria. They have to be properly structured to be excluded from the definition of an investment company.

Here are some examples:

  • Tradition 3(c)(1) Fund: No more than 100 beneficial owners
  • 3(c)(7) Fund: Limited to qualified purchasers
  • 3(c)(1) Qualifying Venture Capital Fund: No more than $10 million from no more than 250 beneficial owners

Which Laws Apply to Advisers?

The Investment Advisers Act of 1940 is relevant here. A private fund adviser may generally make investment decisions on behalf of the fund. Afforded broad discretion, the adviser can make decisions that are in line with the fund’s investment strategy.

But private fund advisers are generally considered investment advisers. That means they are required to register with the SEC or state securities regulators as registered investment advisers. In certain circumstances, however, they may be exempt from registration requirements (e.g. as an exempt reporting adviser).

The size of an adviser and the nature of the investment activities will usually determine which registration requirements apply.

Which Laws Apply to Private Funds Raising Capital?

Private funds raise capital from investors through exempt offerings. These offerings must be exempt from registration under the Securities Act of 1933.

Rules 506(b) and 506(c) of Regulation D are two common types of offerings. The offering cannot rely on either exemption if the fund or certain persons are considered “bad actors.” A bad actor is someone with a relevant criminal conviction, regulatory or court order, or another disqualifying event. Persons covered under this rule include the general partner, certain officers and directors, or any promoter.

The biggest difference between 506(b) and 506(c) is how the fund connects with investors:

  • 506(b): Allows funds to raise capital from investors, but disallows the use of general solicitation
  • 506(c): Allows funds to raise capital by broadly soliciting investors

How My RIA Lawyer Can Serve Your Private Fund

The SEC monitors the activities of private funds to ensure they follow all applicable securities laws. Alleged violations can trigger investigations that may result in substantial penalties. Some of the most common violations concern failure to disclose fees and expenses and conflicts of interest. Having experienced legal counsel can ensure compliance with all laws and regulations. If a potential or actual problem is identified, our attorneys can advise you on how to fix it.

If you’re ready to get started with a private fund, let My RIA Lawyer get to work counseling you. Contact Us Today!

Author Bio

Leila Shaver is the Founder of My RIA Lawyer, a law firm that provides compliance and legal consulting for financial institutions. With extensive experience as a securities attorney and compliance expert, she has served as Chief Compliance Officer and General Counsel to RIAs, BDs, and TAMPs with billions in assets under management.

Leila understands the challenges RIAs face and is committed to helping RIAs streamline their processes, mitigate risks, and ensure compliance with regulatory requirements. She received her Juris Doctor from Atlanta’s John Marshall Law School and is a West Georgia Young Lawyers’ Association member. Leila has received numerous accolades for her work, including the Carroll County Bar Association’s Outstanding Young Lawyer Award in 2017.

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