Opportunity Zone Magazine Volume 1, Issue 3 - Page 79
THE SECURITIES LAWS LANDSCAPE FOR OZ FUNDS AND THEIR MANAGERS
79
Being mindful of what
constitutes a ‘security’ is
fundamental to understanding
how the securities laws apply
to a QOF and its management.
Fund sponsors and managers should carefully scrutinize their
operational plans, business structures, and organizational
structures to determine if, and to what extent, these securities
laws apply and the compliance implications. For example,
a fund manager that is an “investment adviser” may be
prohibited from earning a ‘carried interest’ based on the
performance of the QOF to the extent that QOF investors are
not “qualified clients” under the Advisers Act. Learning that
after the fact would probably be a blow to any hardworking
and successful QOF manager. Thus, structuring the
transaction to help assure the fund manager is exempt from
these restrictions is often a critical objective.
WHAT IS A “SECURITY”?
Being mindful of what constitutes a ‘security’ is fundamental
to understanding how the securities laws apply to a QOF
and its management. This is especially true since the OZ
Incentive encourages the use of a dual-tier structure for
purposes of the working capital safe harbor. Under the dualtier
structure, substantially all of the QOF’s assets consist of
interests in one or more lower-tier qualified opportunity zone
business entities, namely opportunity zone stock (OZ Stock)
and qualified opportunity zone partnership interests (OZ
Partnership Interests). With this dual-tier structure, the QOF
regulatory position more closely resembles a hedge fund than
a traditional operating company or real estate investment
vehicle.
THE REGULATORY LANDSCAPE
Four primary acts embody the core of the federal securities
laws. Funds and their managers must comply with each
of them. First, and most famous, is the Securities Act of
1933 (Securities Act), which regulates the offer and sale of
securities, including interests in the QOF. Regulation D,
which provides the “accredited investor” exemption utilized
by most QOFs and operating companies, stems from the
Securities Act. Next, the Securities Exchange Act of 1934
governs secondary trading of securities (like in the stock
market, for example). It is less relevant to most QOFs. The
Investment Company Act of 1940 (Company Act), however,
regulates “investment companies,” including more broadlyheld
QOFs, potentially. Lastly, and perhaps of greatest
need for attention, is the Investment Advisers Act of 1940
(Advisers Act). The Advisers Act regulates “investment
advisers” and requires Securities and Exchange Commission
(SEC) reporting and registration, or compliance with statespecific
requirements, depending on the total amount of its
regulatory assets under management (RAUM). Without
careful planning and analysis, a QOF manager and/or others
could easily and inadvertently be an “investment adviser,” and
be subject to rules governing management fees, performance
compensation (e.g., a ‘carried interest’), custody of funds,
recordkeeping, and mandatory disclosures.
Understanding what is, and is not a “security” is central
to determining the application of these laws to the QOF
and/or its manager. The term “security,” as defined in the
securities laws, includes “any note, stock [and] investment
contract,” among a seemingly all-encompassing list of other
instruments or financial arrangements. OZ Stock, like all
other corporate stock, is always a security. A partnership
interest, like an OZ Partnership Interest, is a security if it is
an “investment contract,” which common law says consists
of four principal elements – (1) an investment of money; (2)
Congratulations to
Marc Schultz on being
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Opportunity Zone Attorneys.
Committed to being your perfect fit. TM
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Marc L. Schultz | 602.382.6358 | [email protected]
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