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What securities laws should Qualified Opportunity Fund issuers be aware of before they start raising capital from investors? And what are the major differences between the different types of private placement offerings?
Clem Turner is a New York-based corporate and securities attorney for CSG He leads the firm’s alternative capital practice and specializes in Opportunity Zones, among other alternative investment vehicles.
Click the play button below to listen to my conversation with Clem.
- Under what circumstances a Qualified Opportunity Fund would be subject to U.S. securities laws.
- The different types of SEC exemptions that Qualified Opportunity Funds can be offered under.
- An explanation of a private placement exemption offering under Regulation D, and the differences between Rules 506(b) and 506(c).
- How Regulation A+ differs from Regulation D in terms of investor pool, cost, and disclosures.
- The ease of compliance but limitations on fundraising of Regulation CF, compared to Regulation D and Regulation A+.
- Why most Qualified Opportunity Funds will opt for a Regulation D exemption under Rule 506(b) or 506(c), as opposed to Regulation A+ or Regulation CF.
- The pros and cons of Reg D Rule 506(b) vs. 506(c).
- A breakdown of the SEC’s new eligibility criteria for accredited investors.
- Anti-fraud obligations that Qualified Opportunity Fund issuers must meet and the importance of a thorough due diligence process.
- What should be disclosed in a Private Placement Memorandum (PPM).
Featured on This Episode
- Clem Turner on LinkedIn
- SEC Regulation D | Rule 506(b) | Rule 506(c)
- SEC Regulation A+
- Regulation Crowdfunding (CF)
- Securities Act of 1933
- Section 4(a)(2) of the Securities Act, formerly known as Rule 4(2)
- SEC Modernizes the Accredited Investor Definition
- CSG Client Alert on New Accredited Investor Definition
Industry Spotlight: CSG
Chiesa Shahinian & Giantomasi (CSG) is a regional law firm with offices in New Jersey and New York. The firm’s practice areas include corporate, litigation, government, real estate, intellectual property, environmental, fidelity and surety law, white collar, public finance, trusts and estates and renewable energy.
Learn more about CSG:
About the Opportunity Zones Podcast
Hosted by OpportunityDb.com founder Jimmy Atkinson, the Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.
Jimmy: Welcome to the ”Opportunity Zones Podcast,” I’m your host, Jimmy Atkinson. What are some of the main securities law considerations for opportunity zone investors? Joining me today to tackle this issue is corporate and securities attorney, Clem Turner. Clem joins us today from his home office in New York City. Clem, thanks for taking the time to be with us today. Welcome to the show.
Clem: Thank you for having me, Jimmy. I’m looking forward to it.
Jimmy: Yeah. Looking forward to having you here as well, Clem. I know we’ve been trying to get you on the podcast for quite some time, so very excited to have you here today. So today we’re gonna focus on securities law. I’m excited about that. It’s not the most exciting topic, but I’m excited about it because I’ve had over 100 episodes of this podcast and we haven’t ever had an episode that’s gonna be focused on securities law like this one will be. So Clem, to start us off, talk to us about when do qualified opportunity funds start becoming subject to securities laws or are all QOFs subject to securities laws or only some? Maybe you can go into that for us.
Clem: I’d be happy to. The rule of thumb is very simple. Any time you raise money from investors by selling equity, you are subject to the United States securities laws. So any QOF out there, qualified opportunity fund, that’s raising capital and selling stock, LLC interests, membership units, partnership units, what have you, you’re going to be within the jurisdiction of the SEC and we’ve gotta follow their rules and make sure you raise your capital in a compliant manner.
Jimmy: Right. That makes sense. So if I’m doing a small self-funded deal and just getting a very simple QOF set up, I don’t necessarily need to register as a security or file for an exemption from SEC registration, is that right? But once I start raising capital from outside investors. What about friends and family? If I’m sourcing capital from confirmed close friends and family, when exactly do I need to start worrying about SEC rules?
Clem: Well, we could take a quick second and kind of go into why these matter and then I can answer that a little bit better. The securities laws are always applicable. They always govern your rate. However, the SEC, really isn’t going to concern itself with your $300,000 raise amongst your aunts, uncles, and cousins and friends. It could, but let’s be realistic they have limited resources and in all likelihood, they’re probably not going to. However, the securities laws give your investors a private mechanism for which to sue you if you have done an offering in a noncompliant manner, and for whatever reason they want to sue you. So if you’re doing a small friends and family round, and the likelihood of any of those people suing you is low, then companies do very much take shortcuts with respect to the rule.
But obviously as your raise gets bigger, and as you expand your universe of investors to people that you don’t know, you really wanna be 100% compliance because even though the SEC may not care about your raise, should anything go wrong with your raise, whether it had something to do with you or not a hurricane knocked down the foundations and the project shot. If you violated securities laws, those investors have a way to come after you in federal court, and it’s strict liability, meaning there’s no, “Hey, but I was a good guy” defense. You know, there’s no, it wasn’t my fault defense. If they can prove that the raise wasn’t compliant, then they’ll be able to get their money back. And so it’s a sliding scale analysis as to the level of risk that you wanna undergo as an issuer doing a raise.
Jimmy: That makes perfect sense. Yeah. So certainly if you’re raising money from outside investors that you don’t know particularly well, or you only met once or twice, definitely you’re gonna wanna adhere to securities laws as best as you can, as best as your budget will allow. But yeah, again, if you’re just doing a simpler raise, you’re still subject to the securities laws, but you might need to be a little bit less worried about them, depending on how well you know your investors or especially if it’s just you doing the raise, you don’t really need to worry about it too much at all I suppose.
So Clem, I do wanna dive into the different types of offerings or SEC exemptions. But you know, before we continue, maybe we could get a little bit more background on you, Clem. I know you’re a corporate and securities attorney at CSG. Can you tell us a little bit more about how you got to where you are today and what some of your areas of specialty are?
Clem: Sure, sure. I’d be happy to. I’ve been a practicing lawyer for almost 25 years now. Out of law school, I went to a family firm known as Skadden, Arps, Slate, Meagher & Flom which for those of you who know the firm it’s a pretty big family. You know, that’s one of the largest firms in the country, very well thought of corporate firm. And that was where I learned the securities law and was kind of educated into the practice of how to be a securities lawyer. I went to another big law firm that was primarily based out in California that subsequently went under, but my initial education as a securities lawyer in big law firms was six years.
And after that, I worked at some smaller firms and now I find myself at a very well-respected regional farm called Chiesa Shahinian & Giantomasi which we refer to a CSG which is based in New Jersey. I’m in their New York office. They have several New Jersey offices and clientele primarily in the Northeast area. Although I have opportunities zone clients in California New Mexico and across the United States.
Just to give you a little bit more background about me, I lead the alternative capital group at CSG, alternative capital serves as a catchall for capital raising activities that are not your straight, traditional private equity offerings. So I do a lot of offshore foreign immigration investment work. I do opportunities zone investment work, I’ve done new market tax credits work. And any kind of quirky federal program that help investors raise capital by giving your investors some benefit, that’s a program of interest for me that we can help issuers navigate as they seek to get investors through those respective programs.
Jimmy: Terrific. Yeah. Anything that has a little bit of quirkiness to it, Clem, you’re the guy, it sounds like it’s CSG. That’s great.
Clem: Yeah, absolutely.
Jimmy: Good. And there’s certainly a lot of quirkiness to opportunity zones and qualified opportunity funds, particularly since they’re such a new investment vehicle. And we just had the final regs issued less than a year ago. So I know a lot of people still trying to figure it out. And today we’re gonna be talking a lot more about how securities laws can affect qualified opportunity funds. So let’s dive in now Clem, into the different types of exemptions from SEC registration, the different types of offerings that you’re gonna see among qualified opportunity funds. Can you walk us through each one and just so I can kind of paint a roadmap for our listeners, we’re gonna be talking about Reg D both rule 506(b) and 506(c), we’ll touch briefly on Reg A+, Reg CF and then we’ll also discuss Rule 4(2) a little bit as well, but first let’s start with Reg D, Rule 506(b) and 506(c). Clem, take it away. Just kind of dive into all the different types of exemptions for us if you don’t mind.
Clem: Glad you asked that question. Let’s chat for a bit as to why these things are even called exemptions, because then it’s gonna be helpful to realize how important it is that you comply with an exemption. The reason they’re called exemptions is because the securities laws require anybody raising money through an equity security to register with the SEC. And SEC registration is essentially conducting an IPO, which I’m sure your audience is familiar with, an Initial Public Offering. Those are incredibly expensive and very time-consuming processes, but the SEC, recognizing this, made certain specific exemption that if issuers followed, they would be able to raise money with equity and not necessarily need to go through the IPO process.
One such exemption is Regulation D which is the Private Placement Exemption. And these are all about the mechanics of fundraising. There really isn’t anything substantive with respect to any of these exemptions, but if you are following Regulation D, then the one truism, whether using 506(b) or 506(c), is that your investors have to be accredited. In 506(b), you can rely on your investors filling out a questionnaire and self-certifying by checking the appropriate box. You know, yes, I have net worth of over a million dollars, which is one of the criteria or they checked the box I have annual income of $200,000 or more, or household income of $300,000 or more. You know, those are the two ways in which individuals has been able to qualify to be an accredited investor for years.
If you are using 506(c), the self-certification is not going to work. Your investors must have an independent third party verify that they are an accredited investor. However, to make up for that added bit of compliance, the SEC will allow you to advertise your raise to the general public if you use 506(b). So 506(c) is in a nutshell is one of the easiest ways that you can engage in crowd financing, because you can go out to the crowd. You can go out and be a website, but you could also do radio TV, billboard, whatever newspaper, whatever work, any form of mass advertising will be compliant under Reg D 506(c) so long as every investor who invests has either an accountant, a financial planner, a broker, a lawyer, some professional examine your finances and say, yes, this investor is accredited. That’s the very basics, 506, B and C
Jimmy: So that’s Reg D. And just to reiterate, those two different types of exemptions under Reg D, whether it’s 506(b), or 506(c), all of the investors need to be accredited. And there’s some differences between the two, which I wanna dive back into in a minute. I believe, correct me if I’m wrong, Clem, that the vast majority of qualified opportunity funds are gonna file for the Reg D exemption under either rule 506(b) or 506(c). Is that correct?
Clem: That is correct.
Jimmy: But there are a few other types of exemptions that I want you to go over for our listeners before we dive further into Reg D. So can you go over Reg A+ and Reg CF now too?
Clem: Certainly. Reg A+ and Reg CF allow issuers. And just to be clear, I think I’ve used the word issuer a couple of times. That’s an entity that’s going to be issuing securities and exchange for money. So that’s the entity that’s actually raising the money using the securities law, just so you understand what I mean there.
Jimmy: And for our case, we’re talking about qualified opportunity funds would be the issuer, right?
Clem: Exactly right. Exactly right. So the issuer or the qualified opportunity fund, if they were interested in selling equity to investors who were not accredited and the securities laws give them essentially two ways to do that, Regulation A+, which is a very heavily regulated process. And the SEC winds up in Reg A+ the SEC reviews your disclosure document, which we’ll get into later, there are significant requirements on issuers, such as they have to have audited financial statements, the disclosures that they have to give are specifically delineated in the Regulation A+ regulation and a raise under Reg A+ is significantly more expensive than a raise under Regulation D due to the added disclosure requirements, as well as accounting requirements as well as there may even be ongoing reporting requirements. With respect to Reg A+, the benefit of which is that you can now sell to unaccredited investors, but you know, ultimately the issue is whether that’s worth it.
And I’ll pause there and talk about Reg CF. Reg CF is a little bit easier to navigate from a compliance perspective. However, it’s a little bit easy to navigate, but it does also allow you to raise money from unaccredited investors. However, the amount of money that you can raise from a non-accredited person is significantly limited. I think it caps out at $2,500, but there are certain percentages of net worth or annual income that investor can’t invest beyond that certain threshold.
So in an offering where you’re looking to raise several million dollars, you would need a considerable amount of unaccredited investors under Reg CF, given the thresholds and limits that are applicable to how much any one investor can give to any one fund. And ultimately, when you step back and look at Reg A+, or Reg CF, you have to ask yourself as a fund manager, how many unaccredited people out there do I think even have capital gains that would enable them to take advantage of this program. And if you would imagine that number is small, then it likewise follows that the pool of unaccredited investors interested in making investments in opportunity fund is probably a small one, and so it’s probably not worth the extra compliant to have your offering be suitable for unaccredited investor participation.
Jimmy: Right. Which is why most issuers will just rule out those two types of exemptions, Reg A+, and Reg CF and the vast majority of qualified opportunity fund issuers are filing exemptions under Reg D.
Clem: I was gonna say, yeah, Reg D is much simpler to use than Reg A+ or Reg CF, and doesn’t require any involvement with the SEC, either beforehand or afterwards approving disclosure documents and what have you.
Jimmy: Right. That makes a lot more sense. If you’re not going after unaccredited investors anyway, as you rightly point out, most unaccredited investors wouldn’t be able to take advantage of a lot of the tax incentives of this program, because you have to have a substantial capital gains in order to qualify for the tax benefits or really to take advantage of any of the tax benefits. So that makes perfect sense. And then there’s Rule 4(2), which we haven’t touched on yet. Can you touch on that briefly and what that means and when a qualified opportunity fund issuer may opt to adhere to Rule 4(2) versus filing a Reg D exemption?
Clem: Sure. Rule 4(2) is the original language that created the concept of a private placement being exempt from registration. It was in the original language going back to 1933. You know, if an offering is private and not and not an offering that is being made to the public, then the SEC has said, okay you don’t necessarily have to go by all the registration requirements in section five. And forgive me for being tactical. Section five is where the requirements for an IPO are laid out. But what happened was, it’s very difficult to actually know what a private, what does it mean to say that an offering was done privately. And for 40 years there was some confusion as people kind of tried to figure it out, and then what happened was they codified Regulation D and said, look, if you meet these requirements that we’re laying out here in Regulation D, then your offering will be considered a private placement and that’s why sometimes you call Reg D referred to as the safe harbor.
If you sail your ship into the harbor that is Regulation D, your offering is state. But let’s imagine a scenario where an issuer has a core of half a dozen or a dozen investors. Let’s say it’s a real estate developer. They’ve been doing projects together for years, and they’re getting a new project together. They submit a request for capital, capital comes in, they pull it in an entity, and otherwise are compliant with other securities laws and are compliant with the opportunity zones rules, that developer hasn’t necessarily submitted investor questionnaires. All these people, they’re pretty confident they are accredited investors, but they don’t have the backup questionnaire to rely on. Clearly, they didn’t independently verify their third party status, so they have technically failed to meet the requirements of Regulation D yet there is a preexisting business relationship, and it’s clear that in all essence, this was a private offering.
Rule 4(2) is going to cover them and give them something to argue if they have an issue later. So Rule 4(2) is kind of like the poor man’s Reg D. You have raised money through a convention, and you believe you did not submit the offering to the public. You know, you believe that you conducted what was essentially private offering, but you have technically not complied with Reg D, you can still argue that you didn’t commit a securities law violation because you were consistent with Rule 4(2).
Jimmy: Perfect sense. The poor man’s Reg D or Reg D light, maybe. Yeah. That makes sense. So Reg D more defensible, but Rule 4(2), a lot easier just to get up and running particularly if you have some experience with the investors in your entity. I suppose that might be the way to go.
Clem: Yeah. And let’s be quick, just a quick aside. As a lawyer I’m never gonna advise you to rely on 4(2). I’m going to say, look you know, these guys just send them the questionnaire why create an issue. But usually these things kind of come up after the fact, and 4(2) is a way to cure an offering where you didn’t necessarily meet the requirements of Reg D but still, you don’t think you breached securities law. So I’m just saying, as an attorney I give it to the public so that they’re aware of it. But as an attorney, it’s always worth just getting the questionnaire.
Jimmy: As an attorney, you’re gonna say, Hey, let’s do this right. Let’s do a Reg D.
Clem: Yeah. Exactly.
Jimmy: Makes sense. Makes sense. So we’re talking about securities laws and how they intersect with qualified opportunity funds. So far today, we’ve talked largely about the mechanics and the process of the raise. The other consideration is the substance of the raise. I wanna get into that in a minute because that deals with private placement memoranda, and all of the issues that surround that topic. But first I wanna go back to Reg D and really break down again, some of the differences between 506(b) versus 506(c). You explained the differences between the two, but what are some of the pros and cons to doing each one. If I’m one of your clients and I’m about to issue my own qualified opportunity fund what are the considerations that I am gonna take into account when deciding whether or not to do a 506(b) versus 506(c)?
Clem: It’s a great question and it is where I spend most of my time educating clients, because as we said, for obvious reasons, A+ and CF are usually not gonna be the preferred exemption going forward. So as I said earlier, the difference between B and C is that 506(c) enables you to do a general solicitation. It enables you to advertise. So if you don’t have a core stable of investors, but you do believe that you have a project that interesting socially-conscious investors are going to are gonna wanna hear about, then 506(c) gives you the ability to target those people through advertising. Maybe it’s Facebook advertising maybe it’s not expensive radio or television advertising, but you certainly can advertise online and through social media.
Jimmy: Maybe it’s advertising, sorry, I gotta get in a plug here. Maybe it’s advertising on OpportunityDb as well, right?
Clem: Absolutely. And I think to the extent you offer that service, which is great, definitely a a great source of in my humble opinion, but issuers funds who are taking advantage of the reach of OpportunityDb in order to get the name of the fund out there to definitely consider what they’re doing and whether they really need to be compliant with the rules for 506(c). You know, for example any kind of an email blast to a list that they don’t have a preexisting relationship with would technically fall under, well, not even technically would fall under a general solicitation webinars even just a listing on your site in an advertising manner. In a manner designed to solicit potential investors, like a banner ad, for example. That would be something that would be deemed as advertising, and a fund could find itself in hot water if they didn’t abide by the requirements of 506(b).
Now having said that, I don’t think that nearly being listed on a database with a bunch of other funds without any other solicitation of information would rise to the level of advertisement but certainly to the extent you are doing an advertisement… to the extent you are doing an advertisement where you are doing a general solicitation, you should make sure you do the extra step of verifying the accredited status of your investors, which frankly is not expensive and not particularly time consuming. There are third party services out there that will verify the accredited status of your investor for something in the neighborhood of 50 bucks in investment. So it’s something you can contract out. It’s not expensive at all. And if you’re unsure if whatever activity you’re doing could cross the threshold of advertising versus just say a database for thing but if you’re unsure what you’re doing crosses into the threshold and becomes advertising just do the verification so so you can sleep at night.
Jimmy: Right. That makes perfect sense, Clem. So, and thanks for the advice there. For me and for any potential advertisers, you are definitely gonna wanna be complying with the Rule 506(c) type exemption. What are some of the, so 506(c) will allow you to do general solicitation or advertising. What about 506(b)? What are some of the benefits to choosing that type of exemption? Why would anybody want a 506(b) as opposed to a 506(c)? When would that come in handy?
Clem: Well, the advantage to 506(b) versus 506(c) is that it’s one less layer of red tape. So whereas 506(c) requires this independent verification of accredited status 506(b) allows the investor to just check a box on a written questionnaire or digital questionnaire if you have that set up, if you’ve set it up through a website and people do that with people are able to do that with technology these days, put the investor self-certified, you know. Whether they do that in writing or whether they do that digitally, they’re checking a box and saying I need via accredited investor test via this category. And we can talk about some of the categories later because there actually have been some changes to the accredited investor rule with let’s not do that right now.
So for 506(b) everything is internal between the investor and the fund. So the investor self-certified and the fund is entitled to rely on that. And this is particularly useful with investors who may have issues with sharing their financial information with independent third party. You know, because 506(c) requires this independent verification, the independent verifier has to see the evidence that you’re presenting for how you qualify. So maybe that’s a pay stub maybe that’s a brokerage statement showing your net worth at a certain level whatever that is, it is. And while certain third party verification services have set up mechanics where they give the investor a number and it’s aligned, and they do their best to make it as confidential as possible, the investor still fundamentally has to share the information.
So if an investor is unwilling to do that, for whatever reason, you’re not gonna be able to take advantage of 506(c), and so you’re firmly in 506(c). Also, again, going back to my early example as to when you might use 4(2), if you have a dedicated body of investors as a real estate developer, and this team of 12 people have backed your last 10 projects, and you don’t need to go into the world solicit investment, then you may as well just be 506(b), have everybody checked the right boxes and move on. You know, the protections that 506(c) afford you in doing a general solicitation just aren’t necessary.
Jimmy: Okay. That makes perfect sense. That’s actually very helpful. I feel like I have a much firmer grasp on all of this now than I did a few minutes ago. So thank you, Clem. I hope it’s been useful for our listeners also.
Clem: I do as well.
Jimmy: So let’s talk about what it means to be accredited. I think most of our audience knows the basics of it, but maybe you can kind of walk us through that a little refresher course from those who already know, and a little crash course for those who don’t know what is an accredited investor exactly? What are the eligibility criteria? And I know that the SEC earlier this year, I think just a month or so ago recently amended that criteria and widened the net so to speak, yeah, they’d lessened the restrictions. They widened the eligible pool of investors. Could you walk us through all that, please?
Clem: Sure. So I’ll do that in two stages. First, I’ll talk about the old rules and what an accredited investor was, and then I’ll talk about what the SEC did to broaden that pool. So originally, an individual accredited investor was somebody who either had $1 million of net worth, not including their primary residence, or had $200,000 of annual income individually, or within a household where the annual income was 300,000. And for a business entity like a corporation or an LLC, or what have you, the business entity had to have total assets in excess of $5 million, right?
And then there was also a lesser known one that directors and officers of the issuer would also deemed to be accredited investors. So what the new rules did was add a new category that enabled somebody to qualify as an accredited investor based on their knowledge and not on their net worth. So if you’re an individual and you don’t meet that monetary threshold, but you were sophisticated with respect to investment or or finance, or what have you, the SEC said that you will be able to get a certain professional certification or a certain designation, and even contemplated, there are being certifying institutions out there created at some point in the future that could give you a course and you could pass it or give you a task and you could pass it, and you would then be considered an accredited investor.
And initially, the SEC pursuant to this expansion has said that anybody who has a Series 7 securities license or Series 65 or Series 82, and just generally, let me just take a step back from the numbers. Those licenses are required to sell securities. So for example, somebody that has a Series 7 has passed a task given by the SEC that deals all about offering and both private offerings and public offerings. So to the extent they pass, they had certified knowledge about the working of public and private equity. So somebody with that license is now an accredited investor, and it’s likely that any kind of certifying body that would pop up in the future to give investors a class, to enable them to become accredited would probably have to, I would imagine would probably have to have a curriculum that was similar to what the Series 7 was.
So at any rate, you can qualify because of your education or sophistication. They also expanded the rule that related to directors and executive officers in a fund and said, look, if you’re a knowledgeable employee of the fund you’re an accredited investor. They also expanded it to include family offices. And really, I mean, I think everybody assumed that they were accredited, but now there’s codified language that gives us comfort that they are.
And then true 2020 fashion, the original rule, they said $300,000 of household income, I believe the rule said income with the investor and their spouse that equals $300,000. And I think the new rule said spouse or spousal equivalent in this age of of diversity and inclusion. So I just kinda, I gave you the highlights there was also there’s other language in there that I think is less applicable. So I would urge people to take a look at the new rule if they have any questions about it. I can also, if you’re interested, Jimmy, I did a client alert on this last month, I’d be happy to forward it to you and you could have a link to it if you’d like.
Jimmy: Absolutely. Yeah. I’ll link to the link to the new SEC rule and I’ll link to your client alert as well, Clem, in the show notes for today’s episode. So if you’re listening out there right now, head over to opportunitydb.com/podcast, and you can find links to these resources on the show notes page for today’s episode with Clem Turner.
Clem: Sure. Yeah. And I think my client alert is a little bit clearer than the SEC’s new codified language. But hey, some people wanna get their news straight from from the horse’s mouth, but I am more than happy for folks to kind of get my summary of what the new rules are and what impacts they may have.
Jimmy: Right. Now, that makes sense. So you wanna get it straight from the horse’s mouth I’ll link to the SEC on the show notes page, where they have it. But if you wanna read it in English, Clem has got a great summary of it and, I’ll link to that as well.
Clem: Thank you for saying that.
Jimmy: I know you couldn’t say it, but I was happy to.
Clem: Right. As a securities lawyer, I don’t wanna insult how the SEC may or may not phrase things.
Jimmy: No, I gotcha. I gotcha. Okay. So let’s stop talking about the mechanics and process of the raise as it relates to private equity fundraising, or in particular, what we’re talking about today is qualified opportunity fundraising. Let’s get into Clem now, the substance of the raise, and I know we’ve been going on for a while here, and we actually are gonna wrap up the episode pretty shortly here because I think this is a little bit of a shorter section of the podcast, but I did wanna talk a little bit about the substance of the raise and how security law gets touched in that regard. Can you go into the specifics on what else qualified opportunity funds need to take into consideration so they adhere to security laws?
Clem: Yes, absolutely. From a substantive perspective, you can’t lie. Okay, thanks. Have a good night, everybody. But seriously, to expound on that, you have something called anti-fraud obligations in connection with a securities rate, and it goes beyond actually not lying to really not committing fraud. And you can say what’s the difference? Well, the difference is you can commit fraud by omission. So you cannot pay things that you should which is just as much a violation of securities laws as the things that you actually say. So you have to, as an issuer as a fund, you have to tell prospective investors, every material fact in connection with the investment opportunity with no material omissions. Said another way you have to provide all of the information that a reasonably prudent investor would consider when making their investment decisions.
So if there is a potential conflict of interest that you don’t wanna disclose, because you feel like it might impact the investor’s decision because you fear it might impact the investor’s decision, then you by necessity then you by rule has to disclose that thing. So you’ve gotta disclose the good, the bad and the ugly, and the extent you hide something from investors about your raise, then you’ve committed a securities law violation. And that’s one thing that’s securities lawyers do that we don’t talk much about, but the process of meeting any fraud liability we do a considerable amount of due diligence.
We look at your project, we look at all the moving part and we help you to identify things that you may not necessarily wanna disclose, but needs to disclose in order to remain compliant and the real issue, like going back to what I think we said at the top of the podcast, to the extent you don’t disclose it. And some bad thing happens to the project that may or may not have had not anything that may or may not have had anything to do with this fascinating disclose. Should something happened with respect to the project like a natural disaster, the fact that there was a material fact that wasn’t disclosed gives your investors the right to sue you in federal court and get their money back, regardless of whether that thing actually played into the downfall of the investment.
So I had this conversation with clients. I know you wanna put your best foot forward. I get it. You know, we’re raising money, it’s a tough environment, but a lot of investors, I think appreciate honesty. And I think it gives them confidence and comfort in the managers. If they see a particular issue that might not necessarily be the best, but they see it brought up in disclosure documents and then address, that I think gives investors a lot more confidence than if they stumble upon something themselves and it wasn’t disclosed. And certainly, if they invest and then they stumble upon it you’ve just given them the right to sue you and get every cent of their investment back. So just things to keep in mind as you go through your offering process and as you put together, your often documents.
Jimmy: When in doubt disclose it, right? And the investor could potentially go after the individual people behind the fund personally, right? They’re personally liable in some cases, is that correct?
Clem: Yeah. Yeah. I mean, to the extent there was fraud, not including an omission that may have happened, just as a result of somebody just not being careful or not doing proper diligence. If the issuer actually committed fraud, then the management of that issue or the owners of that issuer could be personally liable to be invested.
Jimmy: Right. So that’s scary. That’s why it’s a good reason to make sure you have a really good securities attorney looking at all of these risk factors and disclosing them properly. And that’s typically done through a private placement memorandum or PPM. Is that right?
Clem: That’s correct. And that’s why those documents will have 30 pages of risk factors in them in order to meet that anti-fraud obligation, any conflict of interest should be disclosed, permitting issues or problems should be disclosed. You also should have very detailed bios and track records of all of the key principles in the deal. You know, obviously you should describe. If it’s a single asset raise for a specific parcel you certainly should disclose all that you know about that particular parcel, your particular project to really give investors the tools that they need to adequately evaluate the opportunities you’re presenting to them.
Jimmy: Good advice. Yeah, it makes perfect sense. And that’s why these offering documents, these PPMs are sometimes hundreds of pages long, right? Because their needs, there’s a lot of disclosures that need to go into them.
Clem: Yeah. And I also, I had seen this in the market. I just wanna caution your audience and I’ll admit. I’ll admit beforehand, it’s somewhat self-serving advice, but there are a lot of services out there that promise a PPM at some bargain discount price. Those services frequently don’t do any kind of independent due diligence. You know, you typically are sending them information about their project, they’re turning that into a PPM and giving you some boilerplate risk factors that they’ve prewritten and they generate kind of everything at a push of a button.
So while that document may have private placement memorandum on it, and it will certainly visually look like a private placement memo by virtue of all the boiler plate disclosure that it contain, if someone did not actually do due diligence on your specific project and work with you to maybe identify specific items that impact your project, but don’t necessarily put the projects in your direct in the best light, then those I’ll refer to them as just sounded PPMs. These discounts PPMs may not actually meet the anti-fraud obligation because they contain material omissions that haven’t been discovered because there was no diligence.
So I think everyone has heard the adage in life, you get what you pay for. You know, you get what you pay for. So just keep that in mind when you look to analyze how you’re going to ensure your compliance with securities obligation. Keep that in mind when you choose the entity that’s gonna draft the document that protects you from liability.
Jimmy: I think that’s great advice, Clem. Yeah, don’t cut corners when it comes to getting that PPM drafted. It can be as substantial a fee, right? A upfront fee of upfront legal fees to get one of those drafted depending on who you go with. But as you say, you do end up getting what you pay for. I could’ve set up better myself. Clem, we’ve been going on for a while here, so I wanna wrap up the episode today, but thank you so much for coming on. I hope our listeners have appreciated your insight into discussing some securities laws and how they pertain to qualified opportunity funds and the issuing of those qualified opportunity funds and maybe what issuers and investors should be on the lookout for as it relates to SEC matters. Before we go today, Clem, can you tell our listeners where they can go to learn more about you and CSG?
Clem: Oh, I’d be happy to. You can find out more about my firm at www.psglaw.com. You can search through the attorneys for my name and my bio will pop up and you can read all about me. If you like to make it simple, when I send you the link to the client alert, I can also send you the link to my bio. I’d be happy to do that.
Jimmy: Perfect. Yeah, we’ll do that. And for our listeners out there today, I will have show notes on the Opportunity Zones, database website. You can find those show notes at opportunitydb.com/podcast, and there you’ll find links to all of the resources that Clem and I discussed on today’s show. Clem, thanks a lot for being with us today. I appreciate it.
Clem: Thanks for having me, Jimmy. It was fun. It was a pleasure.