Posted by & filed under Compliance.

Contributed by Peter McGale,  Fund Compliance Services, LLC 

Any sale of a security to a U.S. citizen or entity requires state compliance obligations known as Blue Sky filings.  The compliance officer for a private fund must maintain ongoing Blue Sky compliance records for every state in which their funds have investors. And it’s complicated.  Not all sales require filings. Many states have self-executing exemptions which alleviate the need for a Blue Sky filing,  nearly 60%. Other states require annual or periodic renewals of filings, amendments and termination filings. Most states allow electronic filings, but not all. There are many variables to consider when monitoring Blue Sky compliance which includes both federal and state regulatory requirements.

Generally Blue Sky compliance is outsourced to law firms or compliance specialists to make exemption determinations and maintain existing filings. The process is while the fund is actively selling. There are common and persistent assumptions connected to Blue Sky compliance that should be avoided at the risk of non-compliance and possible penalties:  

  • The fund’s Blue Sky was handled when the fund was formed.

A common misconception is that a fund’s initial sales (anticipated and/or actual) were appropriately reviewed for Blue Sky filing obligations and filings were made in the required states.  Many times, however, the fund lacks ongoing compliance resulting in over filing or under filing, as well as missed ongoing filing obligations such as annual sales reports, amendment and termination requirements.  In addition, Blue Sky compliance is an ongoing process that requires monitoring of all sales, redemptions, transfers on a continual basis for filing obligations and to determine if filings are still necessary. 

  • Blue Sky filings should be made in all states where sales occur.

The team of securities professionals at Fund Compliance Services (FCS) will often see funds that have filed in every state they have sold or expect to sell.  In most cases, there are state filing fees for each of these filings. Filing in every state is a very costly strategy for maintaining fund compliance. Most states have self-executing exemptions which may be applicable to the fund and avoid a state filing and the fees, as well as annual renewal fees.  Reviewing a fund, its sales and investors in order to appropriately identify self-executing exemptions is a worthwhile investment in not just good compliance practices but in reducing fund costs. 

  • The fund is offshore and therefore, it doesn’t have Blue Sky requirements.

Frequently, FCS comes across fund portfolios with offshore funds.  One misconception we often see with these funds is that because the fund is offshore, it is not required to comply with state Blue Sky regulations.  All funds that have U.S. investors are required to file Form D with the SEC and maintain Blue Sky compliance in the states in which their U.S. investors reside.  This requires a fund to ensure ongoing monitoring of its sales and investors in order to identify any US investors and any ensuing Blue Sky compliance requirements.

  • A Fund of Funds, Credit Fund, or a fund consisting of only institutional investors does not need to comply with Blue Sky regulations.

This fairly common misconception is incorrect.  Although these funds may have investor types that most often will meet some type of self-executing exemption, the exemptions need to be researched and a fund’s reliance on such exemption should be maintained.  State regulations change frequently. Therefore, having an ongoing process for monitoring existing exemptions and maintaining them is important to remain in compliance with Blue Sky regulations. 

  • Most Frequent Deficiencies Uncovered When Onboarding Funds

As a specialist in Blue Sky compliance for private funds, we have updated or brought into compliance many fund portfolios from law firms and other service providers with common shortcomings.  

Over-filing is the most common. This brings unnecessary attention to a fund by regulators, as well as unnecessary costs and state filing fees.

Filing in states with no sales. Surprisingly we see this often.

Missed filings. Often fines are assessed for late/corrected filings.

Blue Sky recordkeeping, we see scant compliance records with yes or no  determinations for exemption analysis. Compliance records should always detail determinations for exemptions with applicable state exemption citations. 

Conclusion

All of these misconceptions indicate the necessity of strong, ongoing Blue Sky monitoring and review processes in place.  The failure of a fund to keep current can result in costly fines and penalties, offering suspensions, and negative public relations, making the investment in Blue Sky compliance a prudent choice for any fund.


Fund Compliance Services, LLC provides a Single-Source Solution for Federal and State Blue Sky Compliance. The author Peter McGale has more than 30 years’ experience delivering legal information and compliance services to firms requiring emerging technology or innovative service solutions. Peter can be reached at peter@fundcomply.com or 1-609-513-4389.

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