After a year of consultation, the Securities and Exchange Commission came out today with final rules that will allow hedge funds to advertise to the general public.hedge fund advertising.jpg

In exchange, hedge funds will need to make sure that their investors have sufficient income or net worth. Previously, hedge funds got a break if some of their investors turned out to be inappropriately invested based on insufficient net worth, but no longer.

Now, it’s on the funds to figure out who is an “accredited” investor. You can see the new SEC rules here.

We’ve written about this before, in the Hedge Fund Law Report after we launched our Hedge Fund Investor Accreditation Service.

While funds will now be able to rely on tax returns to tell whether someone is “accredited,” there should be plenty of instances when a tax return won’t reveal income high enough to qualify the prospective investor.

That’s when rules about “reasonable” steps to determine net worth kick in.

Some questions we always ask when looking at net worth (and which hedge funds, their investors and the professionals they use ought to ask too):

  • Are all liabilities listed? It’s one thing to list $2 million of real estate holdings (excluding main residence) or securities. But what about liabilities? If an investor has a judgment lien of $1.5 million against him for back taxes, child support or some other dispute, ignorance of that liability may not be excused if it was reasonably easy to find.
  • Personal holdings determine net worth, but so do the holdings of shares (and the liabilities that go with them) in partnerships or other closely-held entities. Is the investor on the hook for money because of a partnership that you don’t know about? Does his New York LLC have a huge liability in California he forgot to mention?
  • What steps were taken to verify that the prospective investor was not omitting other information? Verifying the contents of a deed or a stock certificate is easy enough, but what about looking for judgments against that investor? Which jurisdictions is it reasonable to search? Can you get away with an on-line search, or should you search courthouses on-site? We do the latter, because most legal documents in this country’s more than 3,000 counties are not on line.