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 recognized among the Top 25 Opportunity Zone Attorneys. Committed to being your perfect fit. TM swlaw.com Marc L. Schultz | 602.382.6358 | [email protected] Albuquerque | Boise | Denver | Las Vegas | Los Angeles Los Cabos | Orange County | Phoenix | Portland | Reno Salt Lake City | San Diego | Seattle | Tucson | Washington, D.C. OPPORTUNITYZONE.COM