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Startup Hedge Fund Manager, starting a hedge fund, starting private equity funds

Amendments to Rule 506 and the Startup Hedge Fund Manager

On July 10, the SEC adopted some amendments to Rule 506 permitting private equity funds, hedge funds and venture capital funds to use general advertising and solicitation when offering and selling interests in a fund (the “Amendments to Rule 506”). Amendments to Rule 506 will be effective 60 days after publication in the Federal Register.

Private funds relying on the Amendments to Rule 506 and Startup hedge fund managers intending to rely the Amendments to Rule 506 are cautioned that may only admit investors that are “accredited investors” and must take “reasonable steps to verify” that the investors are accredited investors.

Startup hedge fund managers are cautioned that they must take “reasonable steps to verify” that investors are accredited investors. Under the Amendments to Rule 506, it is not sufficient to rely solely on an investor’s representation that the investor is an accredited investor. The determination of what constitutes “reasonable steps to verify” the accredited investor’s status is based upon an objective assessment by the fund’s manager. The Amendments to Rule 506 contain a nonexclusive list of methods that a fund manager may use to verify that a natural person investor is an accredited investor.

Start up hedge fund managers considering reliance on exemptions from registration as commodity pool operators or investment advisers are cautioned that they may be precluded from relying on the CFTC registration exemptions or state investment adviser exemptions if they intend to take advantage of the Amendments to Rule 506 permitting general solicitation. The CFTC exemption requires that the fund not be marketed to the public in the United States. Similarly a number of state investment adviser exemptions prohibit the exempt adviser from “holding out” to the public as an investment adviser.

Startup hedge fund managers are cautioned that even though the amendments to Rule 506 only require that investors be accredited investors, SEC-registered advisers and many state investment advisers (as well as advisers exempt under California law) can only charge performance fees to investors who meet the “qualified client” threshold.


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