Directed selling efforts

Directed selling efforts are marketing activities that specifically target people living in the United States when selling securities from offshore funds Offshore fund An offshore fund is a hedge fund established outside the United States, typically in low-tax jurisdictions like the Cayman Islands or British Virgin Islands. These funds primarily serve non-U.S. investors and U.S. tax-exempt organizations by offering tax advantages and greater regulatory flexibility than domestic fund structures. . These activities can be a major problem because they can disqualify an offshore fund from important legal protections that allow it to avoid U.S. registration requirements.

Essentailly, if an offshore fund wants to stay "offshore only" and avoid complex U.S. regulations, it cannot actively market to Americans. Any marketing that specifically targets U.S. residents is considered a "directed selling effort."

Regulation S SEC Regulation S Regulation S provides a safe harbor from U.S. registration requirements for securities offerings conducted outside the United States, commonly relied upon by offshore hedge funds to avoid U.S. registration while still permitting limited U.S. investor participation. is a U.S. law that creates a safe harborA regulatory provision that provides protection from liability or enforcement action when specific compliance requirements are met.—essentially, legal protection—for offshore securities offeringsA securities transaction that occurs outside the United States, with offers not made to persons located within the United States.. The basic idea behind this law is simple: if a securities offering truly happens outside the United States with no significant connection to the U.S. market, then U.S. securities laws should not apply.

However, this protection comes with strict conditions. One of the most important conditions is that funds cannot engage in directed selling efforts to the U.S. market during specific "restricted periods."

To qualify for Regulation S protection, offshore funds must meet two fundamental requirements:

First, the offering must be an offshore transaction. This means the fund cannot make offers to people located in the United States.

Second, there must be no "directed selling efforts" specifically targeted at the U.S. market during the applicable restricted periodA specified timeframe during which additional restrictions apply to securities offerings under Regulation S to prevent improper resales into U.S. markets.. This restricted period varies depending on the type of securities and issuer, but it generally lasts from 40 days to one year.

These requirements work together to ensure that the offering truly has no meaningful connection to the U.S. market.

Understanding who qualifies as a U.S. person is crucial because directed selling efforts restrictions apply to marketing targeted at these individuals. Under Regulation S, a U.S. person includes:

• Any individual who lives in the United States
• Any partnership or corporation created under U.S. laws
• Any estate where the executor or administrator is a U.S. person
• Any trust where a trustee is a U.S. person
• Any branch or agency of a foreign company located in the United States
• Various other types of accounts and entities with significant U.S. connections

This definition is quite broad and captures many different types of individuals and organizations with ties to the United States.

Many different marketing activities can be considered directed selling efforts, including:

• Advertising or promotional materials distributed within the United States
• Seminars, conferences, or meetings held in the United States to promote the fund
• Direct solicitation of U.S. residents through phone calls, emails, or personal meetings
• Internet marketing that is accessible to U.S. residents without proper protective measures
• Using U.S.-based intermediaries or agents to contact potential American investors
• Making sales conditional on agreements to resell securities to U.S. residents

The key factor is whether the activity specifically targets or reaches U.S. residents, rather than just happening to be accessible to them.

Beyond avoiding directed selling efforts, Regulation S requires funds to meet additional conditions that fall into three categories. The specific category that applies depends on characteristics of the fund and its securities.

Category 1 applies when the fund qualifies as a foreign private issuerAn issuer incorporated or organized outside the United States that meets specific criteria regarding U.S. ownership and business activities, qualifying for certain regulatory exemptions. and can reasonably believe that either there is no substantial U.S. market interest in its securities, or it meets certain other specific requirements. Categories 2 and 3 have progressively more restrictive requirements and longer restricted periods.

Each category has its own set of rules about restricted periods, additional offering restrictions, and certification requirements.

Offshore hedge funds Offshore fund An offshore fund is a hedge fund established outside the United States, typically in low-tax jurisdictions like the Cayman Islands or British Virgin Islands. These funds primarily serve non-U.S. investors and U.S. tax-exempt organizations by offering tax advantages and greater regulatory flexibility than domestic fund structures. use several strategies to avoid directed selling efforts and maintain their Regulation S protection:

• Geographic restrictions: They limit marketing activities to specific non-U.S. locations and avoid any promotional activities within the United States.
• Marketing material review: They carefully review all marketing materials and distribution arrangementsContractual relationships and processes for selling or placing securities with investors, including intermediary arrangements. to ensure nothing specifically targets U.S. residents.
• Website controls: They implement access controls and disclaimers on websites to prevent U.S. residents from accessing offering materials.
• Staff training: They train marketing personnel to understand and comply with Regulation S requirements.
• Documentation: They maintain detailed records showing the offshore nature of all offering activities.
• Third-party coordination: They work closely with placement agents and intermediaries to ensure these parties also comply with the restrictions.

For offshore hedge funds, staying compliant with directed selling efforts restrictions is not just a legal technicality—it is essential for maintaining their business model. If a fund accidentally engages in directed selling efforts, it could lose its Regulation S protection and suddenly become subject to full U.S. securities registration requirements.

This would typically mean the fund would need to register with the Securities and Exchange Commission, comply with extensive reporting requirements, and follow numerous other regulations designed for U.S. domestic offerings. These requirements are often incompatible with typical hedge fund structures and strategies.

Therefore, fund managers must continuously monitor their marketing activities, distribution arrangements, and ongoing compliance with the prohibition on directed selling efforts.

Directed selling efforts restrictions under Regulation S do not exist in isolation. Fund managers must coordinate these restrictions with other securities law requirements.

For example, they must also comply with restrictions on general solicitationPublic communications or advertisements directed to potential investors, prohibited under Rule 506(b) but permitted under Rule 506(c). under Regulation D SEC Regulation D Regulation D provides exemptions from SEC registration requirements for private placements of securities, with hedge funds typically relying on Rule 506(b) for traditional private offerings or Rule 506(c) for offerings involving general solicitation. , which applies to many private placementsA securities offering that is exempt from public registration requirements and typically limited to accredited or sophisticated investors.. Additionally, if the fund manager is registered as an investment adviser in the United States, they must follow advertising rules under the Investment Advisers Act Investment Advisers Act of 1940 The Investment Advisers Act of 1940 is the primary U.S. legislation regulating investment advisers, including hedge fund managers, establishing registration requirements, fiduciary duties, disclosure obligations, and compliance standards for advisers meeting certain thresholds. .

Successfully managing an offshore fund requires understanding how all these different regulatory frameworks work together and ensuring that marketing activities comply with all applicable requirements simultaneously.