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Real estate securities laws that apply to Qualified Opportunity Funds can have a huge (and often times ignored) impact on OZ developers and project sponsors.
Coni Rathbone, real estate and securities attorney at Dunn Carney, joins the show to discuss what real estate developers and fund operators need to be aware of before raising Opportunity Zone capital from investors.
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- The four prongs of the Howey test, and why it often times applies to Opportunity Zone funds.
- When real estate developers and fund issuers should be afraid of securities laws.
- The different options for Qualified Opportunity Fund sponsors when issuing their fund offerings.
- The key differences between registered public offerings, Regulation A, and Regulation D.
- The key differences between Regulation D Rule 506(b) private placement offerings and Regulation D Rule 506(c) general solicitation offerings, and when funds should opt for SEC exemption under one rule or the other.
- How Opportunity Zone reform may impact funds and investors.
Featured On This Episode
- Howey Test (Investopedia)
- Public Offerings (SEC.gov)
- Regulation A (SEC.gov)
- Regulation D (Investor.gov)
- Reg D Rule 506(b) (SEC.gov)
- Reg D Rule 506(c) (SEC.gov)
- Accredited Investor Definition (Investopedia)
- JOBS Act of 2008 (Wikipedia)
Today’s Guest: Coni Rathbone, Dunn Carney LLP
- Coni Rathbone on LinkedIn
- Dunn Carney – Opportunity Zones Practice
- Dunn Carney on LinkedIn
- Get Coni’s 120-page OZ packet: Email [email protected] and [email protected]
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 Jimmy Atkinson. And our discussion today is going to center on how real estate securities laws impact Qualified Opportunity Funds. Joining me to discuss this topic today is Coni Rathbone. Coni is a real estate and securities attorney at Dunn Carney, and she joins us from Eagle, Idaho.
Coni, how are you doing? Welcome to the show.
Coni: Great. Thanks so much. And thanks for inviting me to your podcast.
Jimmy: Yeah, we met very recently, just a couple weeks ago at the Novogradac Conference in Long Beach, California, so great to network with you, Coni and bring you on the show. You’ve got a really sharp mind, and you know Opportunity Zones and securities laws inside and out, so really keen to get your take on those topics today. So to start us off, Coni, big picture question here.
How do real estate securities laws impact Qualified Opportunity Funds?
Coni: Great. And thanks again for the opportunity. I’ve been practicing law for about 35 years, and I’ve been doing real estate and securities work. Basically what that means is finding private financing for real estate projects. And what I have learned over the years is that real estate developers will often put together a limited liability company, and have some of their friends put their money into the limited liability company, and sit back and wait for their developer friend to make the money.
And there’s always a misconception with issuers, and that’s what the real estate developer becomes in that context, because they think, “If I only have one or two investors, or if it’s just friends and family, then there’s nothing I need to do.” And that is completely wrong.
And it was wrong before Opportunity Zones, and it’s wrong in Opportunity Zones. I like people to understand that the Opportunity Zone law is an overlay of existing law. So limited liability companies that were formed prior to the Opportunity Zone law are the same kind of limited liability companies that are formed now.
And similarly, the securities laws that applied to those limited liability companies sales is the same securities laws that apply for Opportunity Zones. And so we start with the definition of a security. And, in this context, it is called the Howey Test, and I won’t go into the boredom of how that came about, but it is a test that has four prongs.
It’s an investment of money into a common enterprise with the expectations of profits. And here’s the kicker, those profits are based solely or primarily on the efforts of others. So if I form a limited liability company to do a real estate development of some kind, and Jimmy says, “Here, Coni, is a million dollars, and I want you to make money for me,” that is a security because Jimmy is going to make money based on my efforts.
He’s going to make his profits based on my efforts. So the thing to remember to take away from this podcast is if you have any entity where someone in the entity is making money, is making profits based on someone else’s efforts, then it is a security, and you need to address the securities compliance issues.
It’s not something to be afraid of unless you ignore it, and then it will come back to bite you.
Jimmy: Yeah, that makes a lot of sense there. Don’t need to be afraid of it unless you ignore it, I like that. So, what about, with respect to Opportunity Zone investing, Qualified Opportunity Fund issuers specifically? What are some different options that they have if they want to be cognizant of securities laws, if they want to issue their fund, if they want to get limited partners into their LLCs or other types of entities properly?
Coni: Great. Okay. So, in the Opportunity Zone Program, the vehicle for doing the project is a Qualified Opportunity Fund. I’m a little disappointed that they use the word fund because when you say fund, people assume big, and that’s not true.
An opportunity fund can be most any kind of entity. Typically, they are limited liability companies because that’s the appropriate entity to hold real property in. And so a fund can be a limited liability company with Jimmy and me, or it can be something that has hundreds of investors, and different rules apply based on who that is.
If Jimmy and I are in a limited liability fund, and it is a member-managed fund, and so Jimmy and I are each pulling the oar on making the money, then it is not a security. And if Jimmy is sitting back waiting for me to make the money, it is a security.
And so you need to evaluate that. If there are five people pulling the oar and five people sitting back, then it is a security. So if we have gone through that threshold to decide whether it is a security, then you have to talk about compliance.
And that means you either have to register it as a public offering. Very few opportunity funds do that. It’s overwhelming and very expensive. You can do a Regulation A offering, which is a mini public offering, or most opportunity funds go the process of complying with what’s called Regulation D, which is private offerings.
And so if you do a Regulation D offering, you have to file a Form D with the federal government, and you need to check the states in which your investors are coming from because there may be a notice requirement of the Form D in your particular state. Now, there’s a further breakdown of Regulation D in terms of doing 505 or 506 offerings.
Most people use Regulation 506 because you can raise the greatest amount of money there. And Regulation 506 is further broken down into 506(b) or 506(c). And so in a 506(b) offering, which was the only availability until Obama passed his Tax Cuts and Jobs Act.
And, in that offering, you can only sell to people with whom you have a pre-existing business relationship. There could be no advertising or general solicitation. That means you can’t even put it on your website, right, because putting it on the website makes it available to the public.
In Obama’s Jobs Act, they created 506(c), where it allows for advertising in general solicitation, but put some additional restrictions. So if you want to think about 506(b), then you can sell to 35 non-accredited investors and unlimited accredited investors.
But once again, no advertising or general solicitation. An accredited investor is someone who has certain financial characteristics, and the accredited investor rule was recently broadened so that it could apply to additional people. And the basics of it are that the investor has to have made $200,000 for the last 2 years.
Jimmy: In each of the last two years, right?
Coni: In each of the last two years, that’s correct. Or $300,000 with their spouse with the expectation that that is going to continue, or have a million-dollar net worth, excluding their personal residence. And so those are the two elements that people use most. There are different elements with respect to entities and trusts.
And some of the new elements that made it a little broader are that principals of a company will be accredited investors, even if they don’t have the financial criteria. Lawyers and CPAs and investment advisors, certain of them are accredited investors without the financial criteria.
Indian tribes are accredited investors. So there was a basket of additional categories that can be considered accredited investor.
Jimmy: And those were just added about, I think, less than two years ago, was that right? Fairly recently.
Coni: Yes, yes. Those were added last year.
Jimmy: Last year, okay.
Coni: And so, with the 506(b), you can have non-accredited investors, a few, and then you can have accredited investors. Now, as a legal practitioner, my advice to fund managers and real estate developers is to not take non-accredited investors into your offering because those are people that are deemed to have less sophisticated business knowledge, development knowledge, etc.
And so the standards of disclosure that you have to meet if you allow non-accredited investors is substantially more than if it is an accredited-only offering. And, in fact, no written disclosure is required if you are selling only to accredited investors. Now, here’s where legal versus practical meets because I always recommend to my clients that they have some level of written disclosure so that if the deal goes bad, it’s not a he said, she said about what the issuer told the investor about the product and its risks.
So that kind of summarizes the 506(b). If you go to 506(c), that allows for advertising in general solicitation. So that means you can have an open-house type event to talk about the offering, you can put an ad in “The Wall Street Journal” or your local newspaper, you can post it on your website.
Of course, there are restrictions on what you can do in your advertising, but allows you to advertise and generally solicit, which makes it easier to raise the money. And in that 506(c), no non-accredited investors are allowed. And the biggest deal besides the advertising in general solicitation is that accredited investors have to have a certification that they are accredited from a third party.
And that third party can be a third-party certification company. Many of those popped up after 506(c) was proposed. It can be the investor’s CPA, investment advisor or lawyer, but there’s an additional step to certifying the accreditation rather than the 506(b) self-accreditation.
So I’ve talked a lot about, you know, rules and regulations and those sorts of things. Once I have a developer, or an issuer, or a client that does many securities offerings, and if they have ever done one 506(c), I don’t let them go back to 506(b) because there’s too much risk that this issuer met an investor in an advertisement, which would invalidate the qualification of 506(b).
Jimmy: It’s really hard to go from C to B. I guess you could go from B to C as long as you don’t have any non-accrediteds in your issue… in your fund, excuse me, in your security. Well, that was great, Coni. That was essentially, I think, like a seven or eight-minute masterclass in securities laws and how they impact Qualified Opportunity Funds specifically.
So let me see if I can recap very quickly. And correct me if I trip up anywhere. So there are a few other types of regs that we didn’t cover that are used in much more limited fashion, or that you don’t deal with too much. But essentially, you’ve got, I think it was three options for issuing a Qualified Opportunity Fund. Typically, you can do a registered public offering, almost nobody does that.
You can do a Reg(a) mini-offering, almost nobody does that. But the vast majority of these Qualified Opportunity Funds, if they’re done properly, if they do file paperwork with the SEC to begin with, and they should if they are a security, if they rise to that level, file under Regulation D. Then under there, you’ve got a few different options.
There’s 505 or 506, rule 505 or 506. Almost nobody uses rule 505, almost everybody uses rule 506. And that’s been my take, generally, from all the fund managers that I speak with regularly, is they’re almost always, almost exclusively, they are either 506(b) or 506(c). And, by the way, just a plug for my business, I like the 560(c)s because we derive a lot of our revenue from our advertising and our OZ pitch day that we put on a few times a year that allow fund managers to come and actually present their offerings to our audience.
And then, yeah, there’s a good point you made about either having to verify or certify the accreditation status yourself or through a third party. Typically, if you do sign on to a 506(c) fund, if you subscribe to a 506(c) offering, you kind of just generally do that as part of all of the other paperwork that you fill out when you invest in the fund when you sign your subscription docs and wire the money.
It’s a pretty simple step to get that letter from your CPA or attorney. Or, like Coni mentioned, there’s a handful of third-party services that have popped up and do it as well. Yeah. Did I get that right?
Coni: Yes, you got it exactly right. And to further verify that, clearly, anyone participating, any issuer participating in your pitch day has to either be with a public offering, a Regulation A offering, or a 506(c) because you guys are definitely advertising and generally soliciting.
I’m working on an offering right now that is a 506(b), and they wanted their employees to have the opportunity to invest. All of the employees are greatly involved in the project. And so we created a manager-managed LLC in which every employee has substantial duties and is a manager.
And so even though some of those people don’t meet the dollar test, they do meet the principals of the business test. So we are able to count them as accredited because of one of those new elements, one of those new categories of accredited investors, which is principals of the business.
And so every fact pattern is unique and specific. And I just encourage anyone that is putting together limited liability companies for real estate developments or other entities to be business opportunity funds to seek appropriate CPA and legal counsel on the fund issues, and certainly to take a look at the securities issues to see if you need to comply.
And if you do need, what level of compliance is necessary?
Jimmy: Yeah, very good. Good advice there. So what are your thoughts, generally, Coni, on 506(c) versus 506(b)? What do you like to advise funds to do typically? Do you advise them one way or the other, or is that a facts and circumstances test that it kind of depends?
When do you like to tell somebody, “You should be a C,” versus when you should be a B?
Coni: If the issuer has not already identified the investors and knows that they have a pre-existing business relationship with them, then I always go towards the C. And the reason for that is because you can inadvertently step over the line with respect to the “personal relationship” issue.
For years and years, I did securities offerings, and my clients would say, “Coni, you have to find a way for me to advertise.” And my response would be, “You have to go to a Regulation A.” But that regulation previously had a $5 million capital raise limit, and it was also expensive to put together. So the $5 million cap made it kind of inconsistent with the extra work to put one of those together.
Now that they’ve raised that to 50 million, the Regulation A is more attractive. But Regulation A in a public offering, of course, can be advertised. So my creation of 506(b) offerings has substantially been reduced in the last couple of years because people often do not know exactly who they’re going to raise money from.
And in the Opportunity Zone context, remember that the Opportunity Zone benefits only work if people are investing capital gains. And so the issuers or the people creating the fund may have their own set of capital gains, but they may have to search further than before for people that have capital gains that want to invest.
Now, that’s not to say that you can’t put non-gain money in. In fact, I’m working on an offering right now where we’re creating an Opportunity Zone business property entity, a QOZB, we call it.
And we have a couple of different investors who created their own opportunity funds, husband and wife, prior to the end of 2021 so that they could take advantage of that second step-up and bases. They funded their opportunity funds.
So I have two or three husband and wife Qualified Opportunity Funds that are going to invest in my QOZB, the business that’s going to own the real property that’s being developed. They also have other friends that have just regular non-qualified money, either they won the lottery, or they have bases, or they have savings that is not capital gains.
And so I am creating an entity that has three classes of membership interest. One is class A1, that are the funds, the opportunity funds, A2, which is cash, but not qualified cash, and Class B, which is the people that are going to contribute their sweat equity.
And the A2 and the sweat equity people do not get any of the Opportunity Zone benefits. So if it’s 50-50 between A1 and a combination of A2 and B, then at the end of the day, for the wow moment, I call it, which is no tax on the gain that occurs during the hold period.
So, at the end of the day, that will be taxed 50% to the A2 and B, but no tax to the A1.
Jimmy: That’s clever. That’s a clever way of making that different share-class distinction there. I think it makes the accounting a lot easier during that. I’m going to steal that line from you, though, wow moment.
Coni: You bet. Yeah
Jimmy: That’s great. I’ve never heard it referred to as the wow moment, but I’m definitely going to use that going forward, that big benefit, which is eliminating capital gains after a 10-year holding period, right? That’s great.
Coni: And whenever I speak in person, I always make the audience say, “Wow,” with me. And when this first came out, I was talking to the manager of the CBRE real estate office in Portland, and I described the three benefits. And when I described the wow factor, he said, “Oh, Coni, that smoke and mirrors.”
And I know it’s not. It’s really not. Because that last benefit is such a compelling factor that even though the steps up in bases have gone away, even though you can only defer until 2026 right now, there’s a proposed bill to extend that, the last factor is so compelling that even without an extension of the program, I believe we are going to be creating Qualified Opportunity Funds up until December 30th, 2026.
Jimmy: Could you not be creating opportunity funds even through 2027 a little bit?
Coni: Unless it is extended, I think that that is fuzzy.
Jimmy: But isn’t the deadline to invest 180 days after you accrue a gain in 2026? As long as you realize the gain in 2026, you have an additional 180 days beyond that that kind of takes you into 2027, or am I mistaken there?
Coni: Yeah. There’s no specific legislation that addresses that at this point, but that may be doable.
Jimmy: Yeah. Okay. That’s what I’ve been telling people, so I hope I haven’t been wrong there.
Jimmy: Yeah. Well, okay, what about that reform legislation that you just mentioned? You mentioned that the bases step-ups have expired, and currently, the program is set to sunset at the end of 2026. The OZ reform legislation that you referred to is recent bipartisan legislation, a bill that was introduced into both the House and the Senate in early April.
I’ve already covered it fairly extensively on this podcast and on a webinar that I co-hosted with OZworks Group back last month in April. But Coni, I want to get your take on it. What would the bill do exactly, and what are your thoughts on, does the bill go too far? Does it go far enough?
Does it not go far enough? Where do you land?
Coni: Yeah. I have been working in the Opportunity Zone space since about February of 2018. It was passed at the end of 2017. At that time, I was just wrapping up a 10-year practice of representing tenant and common owner groups and workouts. And so it was really timely for me, and I started studying it the minute that it came out and have been focused on it ever since.
Jimmy: You were an early adopter. So just to paint a picture for people who aren’t aware, you were starting to research them before the zones were even designated. Because the zones weren’t designated until July of 2018, and then the funds didn’t really start coming out until about that time, either. So, you predated all that by several months, which is great. Go on.
Coni: I did the first and biggest opportunity fund in Oregon. We did a $330 million offering to build a hotel in Salem, Oregon, and a high rise on the east side of the river in downtown Portland. And so from the beginning of me working on the Opportunity Zone legislation and seeing how it was going to play out, I have always said, “This should not be a program that sunsets, this should be a program that continues.”
And so I have always advocated for a rolling program, which would have a requirement that we pay our taxes 8 years or 10 years after we make our investment rather than on a fixed date. And I talked about it. Jimmy, you know that Novogradac and OZone Expo are the two main conference producers.
And for the last many years, I’ve spoken at each of their two conferences, so four conferences a year, on real estate securities and the OZone program. And so I’ve strongly advocated for that extension. I learned at this last Novogradac Conference that from Shay, who was Senator Scott’s aide and really was fundamental in putting together the program, I chatted with him about it and asked, “Why is the new bill proposing an extension of the program from 2026 to 2028, instead of making it rolling?”
And he had some really interesting insights. First of all, think about the unusual situation we’re in with this in 2022, when everything in the world is polarized, having an actual bipartisan bill proposed. And so that’s one of the big issues.
And the elements of the bill, and let’s see if I can tell them all off the top of my head. One of them is that it extends the date till the end of 2028. Another is that there are a number of reporting court requirements that are added and testing and really measuring impact.
Another is that funds can invest in funds. So in the current legislation, you cannot have a Qualified Opportunity Fund invest in another Qualified Opportunity Fund. In my earlier example I was talking about where Jimmy and I create an opportunity fund, we would sidecar more or less invest in another fund’s Qualified Opportunity Zone business.
And what that does, and if we go back to the securities analysis, if you have a big fund like I created for downtown, and you had a couple that formed a fund at the end of the year where the two different step up in bases is expired, then my fund with my husband and I, or my fund with Jimmy and I could not invest in that big fund, but we would have to put our money directly into the Qualified Opportunity Zone business property.
So just thinking about that, no harm, no foul. If somebody wanted to invest in each of that fund’s investments, both Grand and Salem, then they could make an investment in each. Now, here’s the kicker on that. And that is that the fund is issuing a securities offering, right? They’re bringing in capital gains from people that are going to sit back and wait for Vanessa, who’s the name of my client, to make them money.
But if we have a sidecar, then there is a new issuer, which is the QOZB. And so if I have a fund that is going to invest in her business property, that’s a new securities offering. And so that fund manager has to be willing to document a new securities offering, many of whom are not willing to take that step, and so it really limits the amount of investments that husband and wife LLC can make in their fund.
Jimmy: Right. You have to either find your own deal, essentially, or you have to find a fund that allows you to sidecar and to come with your investments straight into the underlying assets of the fund, the QOZB as it were, right? Yeah.
Coni: And so those are some of the primary elements of the bill. And do I support the bill, I think, was one of your questions. Absolutely. I think that anything that allows more of these investments into disadvantaged areas is a good thing. Another element of the bill is that certain areas, and I’ll use as an example, Oregon’s downtown Portland and the Pearl District in Oregon are in zones.
People have complained about that a lot because they are really not disadvantaged areas in today’s economy, or I should have said the economy two years ago. There’s been a lot of controversy about it. Now, one of my responses to that is that there’s a Ritz Carlton going in in the Pearl District. Should that be an opportunity fund project?
Well, it is. It’s in Multnomah County, and East County and Gresham is also in Multnomah County. And so the tax base that increases in the Pearl District still benefits Gresham. So I don’t think it’s an aberration that that’s included, but one of the elements of the proposed bill are that we decertify certain areas that either were not or are no longer disadvantaged areas and we instead identify new areas, you know, which I think is a good and productive change.
And when I was first reading the decertification, I got really nervous about it. But then I went on to read some really good healthy grandfathering provisions saying that if a fund had already been created in one of these areas that’s getting decertified, it can remain. If somebody had already invested money into a fund based on the prior certification, they would be grandfathered in.
So I like all of those proposed changes. I am cautious about the reporting because I do not want this to be a program that is ever stalled or eliminated because of the level of oversight and political quagmire that it goes into. So, so long as people keep those things reasonable, then I think it could really benefit the program and the communities that need to have these investments.
Jimmy: Yeah, I agree with you. I’ve been very supportive of the bill as well, and I hope it gets passed at some point soon. Time will tell when that may happen, but I think it’s got a very good chance of going through in some fashion, hopefully, sooner rather than later. Well, Coni, it was great speaking with you today.
But before we sign off, where can our listeners go to learn more about you and Dunn Carney?
Coni: Well, my email is [email protected]. I have 120-page packet of information that my assistant will email to you. I don’t know, Jimmy, if that would go through your company or if people should just ask directly, but anyone can ask for that package by emailing Tom Holmes, which is tholmes, and then the same ending, @dunncarney.com.
I’m happy to share information. I’m always happy to get on the phone and brainstorm on my nickel and not yours. So, you know, it’s a great new area of law. A perfect example of the program is that I am working with a client who has owned 1,200 acres in Burns, Oregon, for, you know, generations.
And all of Burns is in an Opportunity Zone, and Burns died 25 years ago when the mill closed. And so we are working on a project to reinvigorate Burns by using a combination of regular development, and stimulus funds, and Opportunity Zone funds to remake that community.
And that is exactly what the program was set out for.
Jimmy: Yeah, exactly right. And with any luck, this bill gets passed as well and can increase the amount of capital that flows in for more years, increase the amount of projects that get done. Well, just a reminder to our listeners and viewers of today’s podcast. As always, of course, I will have shownotes available for this episode at opportunitydb.com/podcast.
And there, I’ll make sure we have links to all of the resources that Coni and I discussed on today’s show. I’ll be sure to link to Coni’s email address, and Tom’s email address, and we can get that packet on over to you. That packet is great, by the way, Coni. I don’t know if you knew this, but I figured out a way to get it, I think about a year or two ago, and it’s very thorough the amount of information that goes in there, so we greatly appreciate your work.
Again, for our listeners and viewers, be sure to subscribe to us on YouTube or your favorite podcast listening platform to always get the latest episodes. Coni, thanks again.
Coni: Thank you.