David Feldman's book, Reverse Mergers: Taking a Company
Public Without an IPO, now in its third printing, was published in 2006
by Bloomberg Press (available on http://www.amazon.com).
View David Feldman's reverse merger blog at www.reversemergerblog.com.
Joseph Smith and David Feldman are coauthors of PIPES:
Revised and Updated Edition - A Guide to Private Investments in Public Equity
(Bloomberg Press, 2005) available on http://www.amazon.com.
In the News
Joseph
Smith referenced in an article concerning
new SEC rule regarding hedge fund registration.
The PIPEs Report, May 1, 2005.
Registration
Uncertainty: Many PIPE Fund Managers
Delay Decision
by
Joe Gose
The
deadline requiring qualifying hedge
fund investment managers to register
as investment advisers with the Securities
and Exchange Commission is seven months
away, and many PIPE fund managers have
yet to determine their course of action.
Several managers are just now beginning
to explore the new rule, which essentially
amends the Investment Advisers Act of
1940 to include hedge funds that for
years have been exempt for registration.
Many other managers aren't likely to
consider the matter until summer.
Given the fact the many PIPE fund managers
will meet the three-pronged test that
requires registrationan investment
pool of 15 or more individual clients,
$25 million or more in assets under
management, and a lockup period of two
years or lessindustry observers expect
the majority of managers to register.
While failing to meet any of those three
thresholds would automatically exempt
a manager from registration, fund managers
seeking to avoid registration are focusing
on two approaches. The first is to simply
employ a two-year lockup period beginning
February 1, 2006, which is the deadline
for registration.
But managers of funds that have closed
by that date can avoid registration
as well, even if the funds have a lockup
test to funds who add limited partners
after February 1-or to funds that launch
after that date. That gives fund managers
a loophole to consider. "I don't think
the SEC would like to hear the word
'loophole'," says Robert Minion, a partner
with Lowenstein Sandler, "but certainly
it's an end-run around the rule."
The two-year lockup provision stems
from a couple of goals the SEC had when
crafting the final rule, Minion says.
The commission first wanted to exclude
private equity and venture capital funds,
which typically lack the liquidity,
exit strategies and mark-to-market valuations
that hedge funds possess. Thus, the
SEC arrived at a two-year lockup because
most hedge funds typically prevent investors
from redeeming their fund shares for
12 to 18 months.
But the SEC also exempted existing arrangements
between hedge fund managers and their
investors from the rule, which effectively
exempts closed fund managers from registration.
If such a fund with less than a two-year
lockup took advantage of the loophole,
but then opened back up after February
and received new investors, the manager
would then have to register.
" For PIPE fund managers, the so-called
end-run may be the only strategy available
to avoid registration. But the fact
that most PIPE funds are relatively
young and operate in a niche space may
hinder a manager's ability to close
a fund by next February. Those same
characteristics also make it harder
to convince clients to accept a two-year
lockup. "This was a very aggressively
debated rule, and it's possible that
the SEC staff thought only the largest
with the best known managers were going
to have the kind of cache to require
a two-year lockup," Minion says. "PIPEs
are a much newer brand of manager, and
they don't have the cushion and luxury
of past performance and earnings to
say, It's a two-year lockup. Take it
or leave it.'"
Differing Strategies
Mitch Levine, found and managing partner
of Enable Capital Management, illustrates
the point. He often has considered a
longer lockup period than the 18 months
he now requires. "I just have one little
issue," he muses. "my limited partners
are not willing to do that." So far
this year, enable Capital has invested
some $3.7 million in 15 PIPEs, according
to PrivateRaise, which tracks issuances
of more than $1 million.
Levine says Enable Capital will register,
and last August it hired Conifer Securities
in San Francisco as administrator to
perform several services, including
record keeping, communicating with limited
partners, accounting and compliance.
Conifer also is assisting with the registration
process. Levine adds that he was a meticulous
record keeper before the push for registration
reached a full steam last summer. "To
me, it wasn't a hard decision for a
hassle," he says of registration. "I've
been in this business long enough to
know that record keeping is critical
and that everything must be done appropriately,
because there are always people sniffing
around."
Mitch Hull, managing director of Hull
Capital Management, manager of a PIPE
fund of funds, says the investment managers
with whom he invests are still undecided
about whether to register. Meanwhile,
Hull himself has yet to closely study
the registration issue, saying that
he intends to scrutinize it this summer.
But he suggests that plenty of PIPE
funds managers will have the option
to avoid registration. "The decision
is really going to be based upon whether
PIPE funds are closing or not," he says,
"and I think most will be closed long
before the deadline."
Hatteras Investment Partners, a multistrategy
fund of funds manager that recently
invested with Hull Capital, decided
to beat the rush and registered in January.
"We felt like it was inevitable for
the government agencies to kick in,"
says Josh Parrott, director of risk
management for Hatteras, "so we just
went ahead and registered."
But other PIPE experts are observing
a generally languid response from investment
managers to the prospect of registration.
Only two fund manager clients have
notified Joseph Smith, a partner with
Feldman Weinstein, about their plans,
and both are opting out of registration:
One has fewer than 15 investors, and
the other has a two-year lockup period.
Those funds are probably atypical to
the overall PIPE fund space, he adds.
Eleazer Klien, a partner with Schulte,
Roth & Zabel, reports that its still
unclear what direction his clients are
leaning.
Bristol Capital Advisors met with its
administrations during the last week
of April to discuss registration, but
Paul Kessler, principal of the firm,
didn't anticipate making a decision
in the immediate future. "Obviously
it's a big question, but we're totally
on the fence," says Kessler, whose firm
has made 17 placements, valued at $11.6
million so far this year.
Further Changes?
An outside shot that the rule could
be amended or even dropped, particularly
given the SEC's contentious 3-2 vote
in favor of the rule last July, is likely
fostering hope and some of the hesitancy
among investment managers. Lobbying
efforts to change the rule are still
underway, and new commission appointments
and speculation about whether Commission
chairman William Donaldson will remain
to see his initiatives implemented also
are muddying the picture.
Additionally, Opportunity Partners late
last year filed a complaint against
the SEC in U.S. District Court in Washington,
D.C., and in the appellate court of
that district, claiming that the Commission
had overstepped its authority when it
finalized the hedge fund registration
rule. In April, Opportunity Partners
fund manager Phillip Goldstein filed
a 56-page brief with the court outlining
his claims that the SEC isn't authorized
to reinterpret the Advisers Act's definition
of "investor" which is at the heart
of the new registration rule. The SEC
is expected to respond this month.
Changes that investment managers would
find unwelcome may occur, too, especially
if a large number of fund managers opt
for the two-year lockup to avoid registration.
If the SEC suspects abuse, Minion says,
it could amend the registration rule
to eliminate the two-year lockup test
and look instead to the holdings of
a fund's portfolio, for example. On
the other hand, the commission could
determine that it has provided enough
protection to investors with the current
rules, he adds, and that it's "buyer
beware" for investors who put money
into funds with two-year lockups.
Behind-the-scenes wrangling notwithstanding,
the general consensus is that the SEC
will push ahead and enforce the rule.
Minion's prediction: managers of some
50% of all hedge funds will automatically
register and would have registered
regardless of the rule. Of the remaining
50%, about 25% to 30% of conventional
hedge fund managers will register, and
35% to 40% of PIPE fund managers will
register. "It's not surprising that
people are just getting around the thinking
about it," he says. "But the clock is
ticking, and the calendar's moving.
It's getting close."
