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Since QOFs can self-certify, how can investors check that they are complying with the regulations?
How can investors protect themselves before investing in a QOF?
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This is a quality of management question. You should receive a private placement memorandum before you invest. Then check that the manager agrees to provide reports. If reports are not given you will have a right to sue. You will have little or difficult recourse if the manager does not comply. The best assurance is to choose a reputable manager with a good track record.
QOFs must self-certify and their tax and informational returns are subject to examination (audit) by the IRS and state tax authorities. If the tax authorities discover errors or misrepresentations affecting qualification, the consequences can be additional tax, interest and penalties for the investors. When it comes to investors checking on a third-party QOF and protecting themselves, this is pretty much a trust-based situation and buyer beware. The investor should see that the QOF is advised by qualified professionals and staffed by individuals possessing the competence and integrity to follow the regulations.
The investors must certainly perform due diligence before investing and obtaining agreement from the fund on the information they will require from them and the timing of the same. For example, the fund may perform an agreed-upon procedure process and obtain independent third-party certification as to compliance with the requirements as well as of the portfolio entities.
First you want to make sure that both your CPA firm and law firm are experienced with OZ funds. Many are not. This does not mean you need to fire your existing team, but make sure the fund has experienced professionals involved. You will want validation that the fund structure is proper, that the assets held are “good” assets and that the fund managers are testing the fund for eligibility frequently, not just at the testing dates. One possible way to promote compliance is to build into the operating agreement penalties against the fund manager (including the right to replace) if they miss compliance testing more than once.
That is a very good question and it is a matter of due diligence. Funds self-certify by attaching a tax form to the QOF tax return. I would suggest the due diligence would include finding out who the tax firm is using to prepare the returns with the certification and who the law firm is as well. It would be no different than due diligence for any investment, if they are a small unknown fund without a professional track record and big reputable organization behind it, I would be careful to do some meaningful due diligence.
I would think as a corporation or partnership you would have standard shareholder or partnership rights, including a review of documents. But I would have to review your documents to be able to advise you.
They need to seek the advice and counsel of attorneys and accountants well-versed in compliance. They cannot rely on themselves or other laypeople. There are simply too many requirements and potential pitfalls. From proper structuring to ongoing satisfaction of certain tests to interpretation of the various safe harbors, these judgment calls are best left to trained professionals.
Review the QOF's financial information, including the balance sheet, to ensure compliance with the 90% asset test. As is often the case, entities into which investors invest must comply with applicable rules. Ultimately, you need to make sure that the operating documents require that the general manager comply with those rules and that there are consequences for failure to comply.
Comfort with the fund manager is important for this purposes. There are accounting firms and law firms poised to help keep track of the various tests and requirements throughout the investment horizon. Ask your fund manager who she is engaging to perform these services.
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