California Redefines “Private Fund”

I’ve spent a great deal of brain power on the definition of “private fund” under the Investment Advisers Act. California has added its own twist on the definition. It’s a twist that is very important to real estate fund managers.

Working through the definition of “private fund” requires wading through the Investment Company Act. Congress chose to define it as a “an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a-3), but for sec­tion 3(c)(1) or 3(c)(7) of that Act”. Then it requires a re-visit to the first week of discussion in a securities law class over what is a security.

Most private funds, including real estate funds, have looked at the exclusions under sec­tion 3(c)(1) or 3(c)(7) as safe harbors from registration under the Investment Company Act. They have very clear requirements fro compliance. With the new definition of “private fund” under the Investment Advisers Act, many real estate fund managers have looked at the exclusion under Section 3(c)(5) and wondered if that will work as an exclusion.

California is the first state to recognize the loophole and proposed changes to its definition of private fund in the proposed changes to Rule 260.204.9:

“Qualifying private fund” means an issuer that qualifies for the exclusion from the definition of an investment company under section 3(c)(1), 3(c)(5), or 3(c)(7) (or any combination thereof) of the Investment Company Act of 1940, as amended….[my emphasis]

Given the twisted definitions under the Investment Advisers Act, fund managers could classify themselves out of the federal level of registration and into the state level. At the state level, a fund manager could find other exemptions and exclusions from registration. Although, the state level definitions are continuing to change and catch up to the changes brought by Dodd-Frank.

I have not worked through the implications of this new definition of “private fund”. I decided I’d rather deal with the Securities and Exchange Commission than a collection of state regulators. For a real estate fund manager with operations in California who didn’t register with the SEC, you may need to re-visit the analysis for your exemption.