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Avoiding a Public Offer Through Private Fund Materials and Communications

We believe the beginning of 2011 is a suitable time to address several key issues facing investment advisers to private funds as they come to grips with the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") and ultimately, registration with the Securities Exchange Commission ("SEC") or applicable states.

Today, we continue our discussion of private fund adviser marketing materials and other communications, focusing our attention to ensuring firms are complying with private fund exemptions from registration under the Securities Act of 1933 and the Investment Company Act of 1940. While these exemptions from registration need to be followed whether registered or not, and are not even related to new legislation, private fund managers will be open to heightened scrutiny by the regulators once registered.

Preparing and Reviewing Fund Materials

Private fund and investment adviser communications must be created with caution. Managers must ensure that they do not make a general solicitation that would violate a fund's exemption from registration. An adviser to a private fund should have a review process in place to verify that materials and communications of the private fund(s) meet applicable requirements. The chief compliance officer ("CCO") of the adviser should have oversight of this process. The preparation of marketing materials and the review process should ensure appropriate disclosures are used and that the firm avoids making any misleading or false statements (as we discussed last week).

How does a private fund manager avoid making a public offer or general solicitation?

Disseminating Materials

First, materials must be disseminated only to existing investors or potential investors with whom the fund or its intermediary has a preexisting relationship. The fund must have a reasonable basis that the recipient of the materials is a suitable investor. Among the ways a fund manager can document this is by using a suitability questionnaire and having a prior relationship with the recipient (or the fund's intermediary having a prior substantive relationship with the recipient).

The Internet

Generally, any materials or communications regarding a fund, even simply using a fund's name in a communication can be deemed as potentially offering securities and, thus, could break the exemption from registration for the private fund. For example, using of a private fund's name or presenting other information regarding a fund on an adviser's internet site could violate exemptions from registration if it is not located in the password-protected section of the site and accessible only to suitable investors. A potentially dangerous practice is when investment adviser personnel discuss the actual private fund they manage on social networking websites such as LinkedIn, Facebook or Twitter.

Press Releases

We have not received detailed regulatory guidance with respect to the use of press releases by both investment advisers and private funds. However, press releases should generally be treated the same as any other material disseminated broadly. Text in a press release should be limited to information regarding the adviser, its services, and publicly available products or offerings.

Conferences and Oral Presentations

References to a private fund made during a conference by adviser personnel or distribution of materials regarding a private fund could be deemed to be a general solicitation. Verbal communication can be just as widely disseminated as written material, if not more so, especially in an age where people have smart phones that can record speeches and presentations which can then be rebroadcast or uploaded to the internet. This could be largely outside the control of a given speaker. It is better to instead discuss general strategies of the adviser and its services. Also remember to subject speeches and other oral presentations to the same pre-review process as written materials including oversight by a firm's CCO.

Final Thoughts

If an exemption is violated, there may be regulatory consequences including having to offer investors the right to rescind their shares. This could result in high expenses if a fund's value has declined. The fund could also be forced to close. Having said all of this, there is a silver lining. With a review process of materials in place, and oversight of persons acting on behalf of a fund, these consequences can be avoided. Simply put, limit dissemination of materials only to existing investors or suitable potential investors with whom the fund or its intermediary has a preexisting relationship.

Finally, if you have any questions, seek guidance from attorneys or regulatory consultants.

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