How Can Hedge Fund Managers Both Advertise and Accept Investments from Non-Accredited Employees, Friends and Family Members?

The Jumpstart Our Business Startups (JOBS) Act has been received by the hedge fund industry with cautious optimism.  Most notably, the JOBS Act eliminates the long-standing and hard-to-justify gag order prohibiting hedge fund managers from “generally soliciting,” or, in plain English, advertising.  The business benefits of advertising are obvious: communicating a value proposition; solidifying a brand; correcting misperceptions; etc.  However, the JOBS Act does not give something for nothing.  In exchange for the ability to advertise, hedge fund managers may only accept accredited investors into their funds.  See “Implications for Hedge Fund Managers of the Rule Amendments Recently Adopted by the SEC to Raise Accredited Investor Standards,” Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  In the majority of circumstances, this is not an issue because the majority of investors are accredited.  But in an important minority of cases, this regime appears to require hedge fund managers to elect between advertising, on the one hand, and accepting non-accredited investors into their funds, on the other hand.  (Under Rule 506 of Regulation D, hedge fund managers may offer fund interests in a “private offering” – faster, cheaper and otherwise preferable to a “public offering” – to up to 35 non-accredited investors; and the JOBS Act does not change this part of the Rule.)  In turn, this matters because hedge fund managers sometimes have occasion to accept investments in their funds from non-accredited investors – persons such as family members, friends and lower-level employees.  While such “tickets” are typically small relative to institutional investments, they can be strategically important and even connected to institutional investments.  For example, many institutional investors like manager employees to have “skin in the game”; and this preference applies across the pecking order, to investments by star portfolio managers, operations and accounting professionals, compliance personnel, etc.  See “Investments by Hedge Fund Managers in Their Own Funds: Rationale, Amounts, Terms, Disclosure, Duty to Update and Verification,” Hedge Fund Law Report, Vol. 3, No. 21 (May 28, 2010).  From the perspective of institutional investors focused on operational due diligence, there are no unimportant employees at a hedge fund manager.  Everyone should be invested, figuratively and, ideally, literally.  See “Legal and Operational Due Diligence Best Practices for Hedge Fund Investors,” Hedge Fund Law Report, Vol. 5, No. 1 (Jan. 5, 2012).  So, the good news is that hedge fund managers can advertise.  The bad news appears to be that if managers advertise, they cannot accept investments from non-accredited friends, family members, employees and others, which can constitute a strategic impairment.  But hedge fund managers are not lawyers.  When confronted with two alternative options, lawyers – at least good ones – will do a thorough analysis and choose the better option.  Hedge fund managers will choose both.  Accordingly, to enable our hedge fund manager subscribers to get the best of both worlds, and to arm our attorney subscribers for conversations with managers, we have worked with sources to identify eight strategies for simultaneously advertising and accepting non-accredited investments.  Those strategies are detailed toward the end of this article.  To provide context for those strategies, this article also describes: Rule 506 and the mechanics of the JOBS Act; the impact of the JOBS Act on hedge funds and managers; the current accredited investor requirement; integration of securities offerings; and the status of SEC rulemaking under the JOBS Act.

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