The Opportunity Zone Program, which has been discussed previously in this blog, was established by the Tax Cuts and Jobs Act in December 2017 to provide tax incentives for long-term investing in designated economically distressed communities. On June 15, 2019, the Securities and Exchange Commission and the North American Securities Administrators Association issued a statement that explains the application of the federal and state securities laws to opportunity zone funds. In their press release about the statement, they point out that there are compliance implications for Qualified Opportunity Funds under federal and state securities laws that needed to be clarified.
The statement, titled Staff Statement on Opportunity Zones: Federal and State Securities Laws Considerations, explains that “Qualified Opportunity Funds (QOFs) typically are pooled investment vehicles through which investors contribute funds to invest in qualified opportunity zones. Depending on the facts and circumstances, these investment vehicles may have to register as investment companies under the Investment Company Act (of 1940).” Under that Act, an investment company is one which is engaged primarily in the business of investing or trading in securities, or in the business of issuing face-amount certificates of the installment type, and owns investment securities having a value exceeding 40 percent of the value of its total assets on an unconsolidated basis. Without an exemption from this definition, the QOFs would be subject to the registration requirements of the Investment Company Act.
However, there are some exemptions that may apply, depending on the factual situation. Section 3(c)(1) of the Investment Company Act states, in part, that an issuer is not an investment company if its outstanding securities (other than short-term paper) are beneficially owned by not more than 100 persons or, in the case of a qualifying venture capital fund, 250 persons, and which is not making and does not presently propose to make a public offering of its securities.
Section 3(c)(7) of the Investment Company Act states, in part, that an issuer will not be an investment company if its outstanding securities are owned exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers” and it is not making and does not at that time propose to make a public offering of its securities. For purposes of this provision, the term “qualified purchaser” is defined by Section 2(a)(51) of the Investment Company Act.
These private investment companies may engage in a general solicitation pursuant to Rule 506(c) of Regulation D while continuing to rely on the exclusions available in Sections 3(c)(1) and 3(c)(7), notwithstanding the language on public offerings set forth in those exclusions.
There is also another possible exemption referred to as the Mortgage-Related Pools Exclusion. Under Section 3(c)(5)(C), an issuer generally will not be considered an investment company if it is not engaged in the business of issuing redeemable securities and if, in part, it is primarily engaged in purchasing or otherwise acquiring mortgages and other liens on and interests in real estate. QOFs that primarily invest in qualifying investments may be eligible for the exemption under Section 3(c)(5)(C). However, with some exceptions, the Commission has taken the position that an issuer that is primarily engaged in the business of holding interests in a pooled investment vehicle that invests in real estate generally may not rely on Section 3(c)(5)(C).
The attorneys at Wilson, Bradshaw & Cao can advise you of all the requirements related to Opportunity Zone Funds, and how to navigate through the registration exemptions that are available.