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The Investment Lawyer Covering Legal and Regulatory Issues of Asset Management VOL. 24, NO. 9 • SEPTEMBER 2017 When Real Estate Investing Involves Securities: An Overview of Advisers Act Registration Obligations for Real Estate Fund Managers By John D. Reiss hile many US real estate fund manag- eliminated the so-called “fourteen-or-fewer clients” ers may not view themselves as being in exemption in 2011, previously unregistered private Wthe business of investing in securities (or fund managers of a certain size were confronted with advising on such investments), a signifi cant portion a potential registration obligation under the Advisers of the industry has reluctantly found itself subject to a Act.1 For many managers that sponsor hedge, pri- registration requirement or other compliance obliga- vate equity, and debt funds, the analysis was and tions as an investment adviser under the Investment remains straightforward: their funds clearly invest in Advisers Act of 1940, as amended (the Advisers Act). “securities” and, as such, they are required to regis- As discussed further below, proceeding without reg- ter as an investment adviser with the US Securities istration is entirely appropriate in the right circum- and Exchange Commission (SEC).2 For private real stances and should be strongly considered, but taking estate fund managers, however, the analysis is often this approach may reduce a manager’s fl exibility in more nuanced. marketing its business and managing its portfolios. Th e Advisers Act defi nes “investment adviser” to As such, each manager’s examination of its status and include (with certain exceptions): options is a bespoke exercise that requires careful con- sideration of its current and anticipated investments, any person who, for compensation, engages in its marketing strategy, its size, and the expectations the business of advising others, either directly and demands of its investor base. Th is analysis is par- or through publications or writings, as to the ticularly important for new and emerging managers, value of securities or as to the advisability of but can also be relevant for more established manag- investing in, purchasing, or selling securities, ers that have thus far remained unregistered (or that or who, for compensation and as part of a may wish to consider de-registration). regular business, issues or promulgates analy- ses or reports concerning securities.3 Impact of Dodd-Frank; Key Advisers Act Defi nitions Th e defi nition naturally focuses on securities When the Dodd-Frank Wall Street Reform because the SEC is dedicated to overseeing the secu- and Consumer Protection Act (Dodd-Frank Act) rities industry. It does not regulate real estate agents, Copyright © 2017 by CCH Incorporated. All Rights Reserved. 2 THE INVESTMENT LAWYER private home sales, or direct purchases of commer- 1934 (the Exchange Act). For the most part, the SEC cial buildings. By way of example, Form ADV, the and courts have interpreted the defi nition under registration statement for investment advisers, lists these various Acts consistently, although in some cir- real estate together with collectibles and commodi- cumstances the defi nition of “security” has been held ties as being “non-securities” that are excluded from to be more expansive in the Investment Company calculating an investment adviser’s assets under man- Act context. Nevertheless, interpretations of the def- agement.4 Real estate investing can frequently over- inition under each of these Acts can be informative lap with securities investing, however, so care should as the SEC has cited to them when engaging in the be taken before a real estate fund manager tries to analysis under the Advisers Act.7 simply opt out of the defi nition. Th e Advisers Act Whether certain real estate-related assets consti- makes it unlawful for an investment adviser to con- tute securities depends on the facts and circumstances duct its business in the United States absent registra- in each case. Th ere is no dispute that certain interests tion or a relevant exemption.5 are not securities. For example, a fee simple interest Th e Advisers Act defi nes “security” as in real estate is not a security.8 Such interests stand at one end of the spectrum. Publicly traded mortgage- any note, stock, treasury stock, security backed securities, passive interests in widely off ered future, bond, debenture, evidence of indebt- REITs or passive interests in any investment vehicle edness, certifi cate of interest or participation such as another real estate investment fund, how- in any profi t-sharing agreement, collateral- ever, are each securities under most circumstances. trust certifi cate, preorganization certifi cate Between these two extremes are various other or subscription, transferable share, invest- real-estate-related assets that must be analyzed based ment contract, voting-trust certifi cate, cer- on the particular facts and circumstances. tifi cate of deposit for a security, fractional undivided interest in oil, gas, or other min- Holding Companies and Joint eral rights, any put, call, straddle, option, or Ventures privilege on any security (including a cer- Many real estate funds hold real estate assets tifi cate of deposit) or on any group or index through holding vehicles or other structures formed of securities (including any interest therein by the fund or by the investment manager on behalf or based on the value thereof), or any put, of the fund. Such a holding company may be a lim- call, straddle, option, or privilege entered ited partnership or limited liability company, for into on a national securities exchange relat- example. Th e SEC has taken the position that lim- ing to foreign currency, or, in general, any ited partner interests in a limited partnership that interest or instrument commonly known as holds and manages real estate assets generally are a “security”, or any certifi cate of interest or securities for purposes of the Securities Act and the participation in, temporary or interim cer- Investment Company Act.9 A general partner inter- tifi cate for, receipt for, guaranty of, or war- est, however, is generally not considered a security rant or right to subscribe to or purchase any unless, for example, the general partner does not of the foregoing.6 participate in management or has any ability to do so (such that while labeled a “general partner” it Virtually identical defi nitions are provided under may be viewed as “relying on the eff orts of others” the Securities Act of 1933 (the Securities Act), the rather than its own).10 If such a general partner also Investment Company Act of 1940 (the Investment formed the underlying limited partnership as part of Company Act), and the Securities Exchange Act of a fund formation process (as opposed to acquiring Copyright © 2017 by CCH Incorporated. All Rights Reserved. VOL. 24, NO. 9 • SEPTEMBER 2017 3 such interest on a secondary basis), this would also contract arises from the Howey case.13 Under Howey, lend further support to the position that such a gen- an investment contract constitutes a security when eral partner interest is not a security. With respect there is: (1) an investment of money; (2) in a com- to a limited liability company, the role of a man- mon enterprise; (3) where a person is led to expect aging member or manager could also be viewed as profi ts; (4) solely from the eff orts of the promoter or substantially analogous to that of a general partner third party. Additionally, analysis of whether a debt for purposes of the foregoing analysis. Additionally, instrument is a note that may be deemed to be a wholly-owned limited liability companies (or other security for purposes of the Advisers Act might be wholly owned vehicles such as subsidiary REITs) are informed by factors set forth in the Reves case under often formed for the purpose of holding one or more the Securities Act (for example, plan of distribution, real estate assets. Generally speaking, if a fund forms an expected secondary market, etc.).14 an entity through which to hold an asset that is not a security, such formation should not constitute advis- “In the Business” ing on an investment in securities. Separately, to fall within the defi nition of an A “joint venture” is also a common construct investment adviser, a person must be “in the busi- in the context of real estate investment. Th e term ness” of providing advice with respect to investing does not necessarily refer to any specifi c type of legal in securities. Th e SEC Staff has said that it “con- entity (a so-called joint venture could be formed as siders a person to be ‘in the business’ of providing a limited partnership, a limited liability company, such investment advice if, among other things, the or even a corporation, for example), but rather is person provides specifi c investment advice on any- a descriptive term implying joint economic partici- thing other than rare, isolated and non-periodic pation along with some notion of joint managerial instances.”15 As such, a real estate fund manager that responsibility. Th e SEC Staff and various courts advises on investments in securities only occasion- have agreed that a joint venture need not be treated ally, and does not hold itself out as providing advice as a security, and the Staff also has accepted that on investing in securities, could potentially make the position even in the case of a joint venturer hav- argument that they do not meet the defi nition of ing just a 25 percent stake, as well as in the case an investment adviser simply because they are not of a joint venture formed as a corporation (which in the business of providing investment advice with issues shares of common stock that are more com- respect to securities.

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