Investment Fund Compliance

1. Investment Company Compliance

An important part in deciding your fund's appropriate structure is ensuring your fund is fully compliant. Entities used as vehicles for investment funds must register with the SEC unless one of the following exceptions is met:

1. 1. 3(c)(1) Exemption Under the Investment Company Act - Can be used for any private fund that has no more than 100 beneficial owners, all of whom are accredited investors. A private fund may have up to 250 beneficial owners and still qualify for this exemption if it is considered a qualifying venture capital fund.
      1. Accredited Investor: Either (1) an individual with gross income exceeding $200K or joint income with a spouse/partner exceeding $300K in each of the prior two years and reasonably expects the same for the current year, or (2) an individual whose individual net worth, or joint net worth with the individual's spouse/partner, exceeds $1M (excluding the individual's primary residence). Additionally, entities owning more than $5M in assets qualify.
      2. Qualifying Venture Capital Fund: A private fund that has less than 250 beneficial owners, has fewer than $12M assets under management, and meets the definition of a Venture Capital Fund (as defined under the Investment Advisers Act of 1940).
         
         1. The Investment Advisers Act of 1940 defines a Venture Capital Fund as a fund that (a) does not invest more than 20% of the fund's committed capital in non-qualifying investments, such as debt, secondaries, public issuances, fund-of-fund investments, or digital assets, (b) restricts borrowing and all other leverage to 15% of the fund size, and repays any related debts within 120 days, (c) limited partner (LP) redemption rights (their ability to cash out of the fund) to "extraordinary circumstances," and (d) represents to investors and potential investors that it pursues a venture capital strategy.
   2. 3(c)(7) Exemption Under the Investment Company Act - Any private fund that has no more than 2,000 beneficial owners, all of whom are qualified purchasers.
      1. Qualified Purchaser: Can be (1) an individual with at least $5M, (2) a family or estate planning entity with at least $5M, (3) an investment manager with at least $25M assets under management, or (4) a qualified institutional buyer under Rule 144A (under Section 5 of the Securities Act of 1933) with at least $100M assets under management.
2. Investment Adviser Compliance
   
   1. Most private funds will be exempt from registration under (1), but considerable regulatory oversight is applied to the fund manager, or the fund's investment adviser. Typically, the size of the adviser's assets under management (AUM) and the type of its activities determine whether the SEC or a state regulator will be the regulator:
      

      1. Size of AUM by the Adviser	Regulated By
         Small Adviser (less than $25M)	State Regulator
         Mid-Size Adviser $25M-$100M)	State Regulator or SEC
         Large Adviser (more than $100M)	SEC

         *Some things to note:
         1. Each state has different regulatory and filing requirements.
         2. Funds that operate in more than 15 states, even if they manage less than $100 million in assets, must register with the SEC.
         3. Generally, most states allow for a "de minimus" exemption from state registration if (a) the investment adviser has no place of business located within the state and (b) during the preceding 12 months, has had fewer than 6 clients who are residents of that state.
         4. To register with the SEC, an investment adviser must typically create an Investment Advisor Registration Depository (IARD) account and submit the whole Form ADV to the SEC. Certain filing fees will apply. Upon SEC approval, the investment adviser must then update the Form ADV annually.
   2. Private fund advisers may also qualify as an Exempt Reporting Adviser (ERA) to avoid more extensive regulatory requirements. Qualifying as a ERA will save time and money for the investment adviser. A private fund adviser may qualify as a ERA if they either (i) solely manage private funds and have less than $150M in AUM across all funds managed, or (ii) solely advise venture capital funds (see Venture Capital Fund definition above under 1(a)(ii)). Here's how to file as a ERA:
      1. Within 60 days of claiming the exemption (typically the date of the fund manager's first fund's initial close), the ERA must file Form ADV Part 1A with the SEC through an IARD account. The ERA must update their filing with the SEC annually.
3. Other Securities Regulation and Compliance

Private funds can't offer their securities to the general public, and instead must raise capital through an exempt offering framework. The most commonly used framework is provided by Regulation D. Regulation D outlines how funds or companies can sell their securities without registering the offering with the SEC. Most private capital is raised under the framework outlined in Rule 506 of Regulation D, either through Rule 506(b) or Rule 506(c). If companies or investment funds can meet the requirements under Rule 506, they avoid the regulations and reporting requirements required by the SEC.

1. 1. Rule 506(b) - A fund manager can raise an unlimited amount of money as long as they do not publicly advertise or solicit investments for the fund.
      1. Fund managers may raise money from an unlimited number of accredited investors (see definition above under 1(a)(i)) and up to 35 non-accredited investors (as long as these are sophisticated investors and they receive additional disclosure documents) as long as fund managers don't advertise the fund or generally solicit investors.
      2. Security purchasers can self-verify their accreditation status; fund managers are not responsible for verification.
      3. To state that the fund is raising capital in a 506(b) offering, the fund checks the 506(b) option when they complete their Form D notice, which the SEC requires to be filed within 15 days of the first close.
      4. Fund managers that initially fundraise under this offering can change the exemption status to 506(c) if they want to advertise their fund.
   2. Rule 506(c) - A fund manager can perform general solicitation and advertising without any limitation on how much capital they can raise, but managers must take reasonable steps to verify that the security purchasers are accredited or hire a third party to perform the verification.
      
      1. Reasonable steps to verify depend on how the purchaser claims eligibility:
         1. If the purchaser claims eligibility based on income, then the fund manager must obtain the purchaser's tax forms for the past two years along with confirmation of the purchaser's income for the current year. The minimum threshold for accredited investors is a $200,000 annual income for an individual or a $300,000 annual income for a married couple.
         2. If the purchaser claims eligibility based on net worth, fund manager's must review the purchaser's assets by collecting proof of their assets and liabilities from within the past three months. These can be obtained through bank statements or brokerage reports. Fund managers must also verify that all liabilities that could impact the purchaser are disclosed. The minimum net worth for accredited investors is $1M, excluding the primary residence. 
            
            **As of March 12, 2025, the SEC issued a no-action letter regarding 506(c) exemption rules. The public's response to these "Reasonable steps to verify" has been largely negative, and as a result very few fund managers lean on the 506(c) exemption. As a result the SEC has created a new safe harbor. If the investor can represent that they aren't financing their investment through a third-party, if the investor's check size is larger than $200k (or $1M if they are not an individual), and the fund manager has a no actual knowledge that the investor is not an accredited investor, then the fund manager does not need to take any more "reasonable steps to verify."**