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News July 27, 2015 Issue

Master the Keys to Successful PPMs and Subscription Documents

A fundís private placement memorandum and accompanying subscription documents are the window through which both investors and regulators view a fund and an adviserís management of it. Take the time to get them right Ė youíll find itís time well spent.

A PPM is meant to be a disclosure document from which potential investors, the SEC and other regulators will learn of your fundís strategies, risks, business management and more. But the SEC is really not all that prescriptive about how it should be written Ė that is instead drawn from industry practice, said Morgan Lewis partner Richard Goldman. There are nonetheless certain touchstones a PPM must hit.

Most PPMs are organized into sections, each covering a different aspect of the fund it represents, such as a†description of the fundís interests, risks, use of proceeds, business management, and conflicts of interest. When creating a PPM, consider the following practices:

  • Make sure itís consistent with other documents. Match a fundís PPM against other disclosure documents, such as Form ADV Part 2A, where some of the same material that is in the PPM will also be disclosed. You also want to ensure consistency with pitchbooks and due diligence questionnaires, said Goldman.
  • Disclose all conflicts of interest. Failure to do so may lead to major problems, not only with investors who need to know this information before they invest, but the SEC, which is currently bringing cases against†advisers and funds that have conflicts of interest they fail to disclose. "Typically, there is nothing wrong with conflicts of interest. They just have to be disclosed and oftentimes policies and procedures need to be enacted so that investors are treated fairly," Goldman said. Conflicts of interest may involve other funds and accounts that a firm manages, and may touch on topics such as allocation of a managerís time and resources, how the manager will allocate trades and expenses, and soft-dollar practices.
  • Customize the risk factors. "These need to be highly tailored to not just the industry, but to the type of securities involved," said Capital Fund Law Group partner John Lore. "Boilerplate risks should not be used." For instance, a fund that invests in fixed†income will have different risks than a fund that†invests in commodities, and those should be clearly stated. PPMs should also avoid adding mitigating language to those risks. Such language would state that while a certain risk might exist, it is a remote possibility or does not apply to the fund for a certain reason, he said.
  • Describe how the proceeds will be used. When possible, include a table showing item-by-item how much is anticipated to be allocated to each category, said Lore. "It can be difficult, if not impossible in many circumstances, to determine exactly how much of the proceeds will be allocated to a given purpose," he said. In such cases, "an estimated use of proceeds is a best-case forecast of how the proceeds will be used."
  • Be careful when using PPMs from prior fundings. It may seem easy to just call up a previous document and plug in current information, but that may not be the advisable path in all circumstances, said Sidley Austin partner Timothy Clark. "Things may have changed since the prior PPM was drafted and you should do a thoughtful review."
  • Donít limit review to attorneys and compliance persons. "Make sure the right people at your advisory firm review the PPM before it goes out," said Goldman. For instance, investment managers should review the investment strategy and risk sections, as well as the conflicts of interest listed. Clark noted that management involvement can help ensure that risk factors and other items listed in the PPM are customized to the offering, rather than relying on stock risk factors.
  • Think like investors and regulators do. Write it so that investors will understand it. "If it doesnít make sense to you, it probably wonít make sense to your investors," Clark said. Be aware that regulators are sensitive to hyperbole and will scrutinize any performance figures used.
  • Limit biographies to those who manage the fund. "You are not required to list everyoneís bio," said Goldman. Doing so may place you in the position of having to update the PPM every time someone leaves the firm. "Typically, the biographies you want to include are those individuals who are managing the portfolio, whether that is one person or a team of people," he said.
  • List all relevant compensation. The SEC wants to know, for instance, whether fund capital is being used to pay the fund manager or other related parties, Goldman said. Organizationally, this information could be included in a conflicts of interest section, estimated use of proceeds, or elsewhere.
  • Donít be afraid to create your unique voice. Writing about your fundís unique features, including how it expects to create value for investors, is what gives your PPM its competitive edge, said Clark. Of course, care must be taken not to overstate your case in a way that draws a regulatorís attention.
  • Make sure the terms offered are customized to your business. One size doesnít fit all and key fund terms such as investment limits, recycling and conflicts management may need to be customized to reflect a firmís investment strategy and business practices, said Clark.
  • Be careful of the word "may." The SEC doesnít like to see this word overused, as in "the fund may do this, the fund may do that," which attorneys may suggest to provide optimum flexibility, said Goldman. "If the fund is already doing something, the SEC wants you to say so," he said. On the other hand, if you are not taking a certain course of action but think you may want to in the future, then use of the word "may" would be appropriate, he said.

Subscription documents

A subscription booklet for investors typically contains a variety of subscription documents, including the subscription agreement, an investor questionnaire, a privacy notice, an additional subscription form and a redemption request form, said Goldman. As with the PPM, there is an art as well as a science to preparing them.

  • Make sure they are user friendly. The subscription agreement tends to be long and technical in nature, and that can be challenging and frustrating to investors who have to complete them. "The longer and more repetitive a subscription agreement is, the more likely investors may not fill out or may incorrectly fill out sections," said Clark. One way to mitigate this is organizing the agreement into sections. For instance, Goldman suggested, you might want to organize the agreement and questionnaire by types of investors, such as creating a separate section for ERISA investors. Subscribers who are not ERISA investors can just skip this section, he said.
  • Make sure they ask for all the necessary representations and warranties. This is where you canít avoid length. Over the past few years, new regulations have resulted in the need to add additional representations and warranties to the subscription agreement, including representations relating to bad actors (under Regulation D Rule 506(d)) and Form PF, Goldman noted.
  • Ensure that your subscription agreement works with your fund limited partnership agreement and other offering documents. Although it is often possible to use a standard form of subscription agreement across multiple fund products, care must be taken to customize the subscription agreement to each fundís governing documents and make other necessary†adjustments based on the facts of your offering, said Clark.
  • Revisit all the documents periodically. Requirements change over time, and these need to be reflected in the documents. Beyond that, it is always a good idea to review the organization of the agreement and other documents in terms of user-friendliness and to search out errors on a periodic basis, Clark said. Itís an ongoing process.