Five Most Common Compliance Questions Answered by our Experts

2 min read

Sep 27, 2022 9:52:49 AM | Assure

Are you staying compliant with your investments? With the regulatory requirements ever-evolving, Investment Fund Organizers and investors need to always ensure that they are in compliance with the Institution of Securities and Exchange Commission (“SEC”). We asked our experts at Assure to address the five most common compliance questions they’ve had to address recently.

I am relying on Rule 506(b) to raise capital for my SPV. It is permitted under that rule to allow up to 35 non-accredited investors to invest. All investors will be accredited investors, but I have a couple of friends and family that want to invest that are not accredited. Can I do this?

The answer is both yes and no. While it is true that under Rule 506(b) you can permit up to 35 non-accredited investors to invest, the actual answer to the question is almost always no. Problems with allowing non-accredited investors into your SPV usually surface when the SPV goes to make an investment. Just like the SPV has to rely on an exemption to issue securities, the portfolio company is also relying on an exemption to issue securities. The portfolio company almost always requires that all investors are accredited, which means the SPV must be an accredited investor. An SPV can meet the definition of an accredited investor by one of two ways:

  • The SPV has total assets in excess of $5,000,000
  • ALL equity owners are accredited investors. You can see that by allowing just one non-accredited investor into the SPV, it can ruin the accredited investor status of the SPV. This would prevent the SPV from making the investment.

How many investors can I have in my SPV?

OnboardInvestors-01Like many regulatory questions, it depends. An SPV must comply with the Investment Company Act. The two most common exemptions for SPVs and Funds are:

  • To comply with Section 3(c)(1) an SPV cannot have more than 100 beneficial owners under the general rule, or no more than 250 beneficial owners if the SPV or Fund is not more than $10M in capital commitment and is a qualifying venture capital fund.
  • Section 3(c)(7) does not have an investor limit, but the SPV is limited to 1,999 beneficial owners under the Securities and Exchange Act of 1934. The caveat with Section 3(c)(7) is that all investors must be “qualified purchasers,” which is typically met if the individual investor owns at least $5M in investments, or all beneficial owners of an entity are qualified purchasers.

Can I create multiple SPV’s to get around the investor limit in Section 3(c)(1)?

The short answer is no. The SEC realized that people might set up multiple entities to get around the investor limit, so they enforce two different doctrines to prevent this. One is called look-through and the other is integration.

  • Look-through: applies when one 3(c)(1) fund invests into another 3(c)(1) fund. Look-through happens in two scenarios:
    • The SPV invests 40% or more of its assets into another fund;
    • The SPV’s ownership of the fund represents 10% or more of the voting securities of the fund. Many SPVs make one investment, which would violate point one above. What this means is that all investors in the SPV will count towards determining the number of investors in the fund which received the investment.
  • Integration: becomes an issue when two SPVs are set up by the same group to invest in the same asset. The integration rule is very broad and is determined on the facts and circumstances. In general, if a reasonable investor would view the investments as the same, then the SPVs will be integrated for purposes of the determined number of investors. If counting all of the investors as if they were in one SPV surpasses the applicable investor limit, then the exemption can no longer be relied upon. If, however, you combine the number of investors and the SPV is still under the investor limit, then there is no violation of the investor limit.

Can I set up an SPV or feeder fund to invest into an institutional fund?

SPV-01Yes, but you need to be aware of some important characteristics of larger funds. Most institutional funds rely on Section 3(c)(7), which means that all investors must be qualified purchasers. In order for the SPV to be considered a qualified purchaser, it must either have $25M in capital commitments, or all beneficial owners of the SPV must be qualified purchasers.

Do I need to register as an investment adviser or exempt reporting adviser?

Most SPV and fund managers need to register as an exempt reporting adviser (ERA), or the equivalent to one in the state where the manager is located. Every state is different, but most have very similar requirements that you find at the federal level.

There are two exemptions found in the Investment Advisers Act that typically apply to SPV and fund advisers.

  • Venture capital fund adviser exemption, which applies to fund advisers that act as an adviser solely to one or more venture capital funds.
  • Private fund adviser exemption, which applies to fund advisers that act as an adviser to private funds (such as 3(c)(1) and 3(c)(7) funds) and has assets under management in the US less than $150M.

Registering as an ERA is generally an easy task. Whether registration is required at the federal or the state level, it will depend on the state and the AUM of the adviser. Our compliance experts at Assure can help you navigate the nuances of registering with the state or the SEC. If you have any further questions about compliance please contact us.