Ropes & Gray’s Hedge Fund Update: August 2011

Here is an excerpt from the Ropes & Gray’s Hedge Fund Update: August 2011. The complete report is available here.

SEC Proposes Rules to Disqualify “Bad Actors” from Reliance on Rule 506 Private Placement Safe Harbor

The SEC has proposed new regulations under Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act that would disqualify certain “bad actors” from relying on Rule 506, the most widely used safe harbor for private placements. The proposed rules reflect the Dodd-Frank Act’s directive to the SEC to issue disqualification rules for Rule 506 offerings that are “substantially similar” to those for Regulation A offerings while expanding the list of disqualifying events to include certain actions taken by state securities regulators.

Persons covered by the disqualification rules. The SEC’s proposal designates the following as “Covered Persons,” the acts of whom could disqualify an issuer from relying on Rule 506:
• the issuer, any predecessor of the issuer, or an affiliated issuer;
• any director, officer, general partner or managing member of the issuer;
• any beneficial owner of 10% or more of any class of the issuer’s equity securities;
• any promoter connected with the issuer in any capacity at the time of sale;
• any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with sales of securities in the offering; and
• any director, officer, general partner, or managing member of any such compensated solicitor.
The investment adviser to a private fund is not named as a Covered Person. The SEC’s proposal solicits comment on whether the investment adviser to a private fund issuer should be made subject to the disqualification regime. However, several comments pointed out that without further tailoring by the SEC, the definition of “promoter” under Rule 405, which includes “any person who…directly or indirectly takes initiative in founding and organizing the business or enterprise of an issuer,” may be broad enough to encompass an investment adviser.