A private fund can buy IPO shares for its whole capital only if restricted persons own no more than 10 per cent of it. Above that, the new issue profit has to be carved out, and the count of who is restricted decides everything.
Under FINRA Rule 5130 a fund may buy new issues for all its investors only if the beneficial interests of restricted persons total no more than 10 per cent of the fund. The test is restricted capital divided by total capital. In an illustrative 250.0 million fund, restricted persons hold 27.0 million, 10.80 per cent, so the fund fails the de minimis and must carve them out: on a 2.4 million new issue profit, capped at 10 per cent, restricted investors receive 240,000 instead of 259,200.
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Rule 5130 stops broker-dealers selling equity IPO shares to accounts in which restricted persons have a beneficial interest. The 10 per cent de minimis is the exemption most private funds rely on. Brokers will ask the fund to represent its status before allocating, and to refresh that representation at least annually, so the compliance officer has to be able to show the number behind it. A separate rule, 5131, deals with allocations to executives of companies with investment banking relationships and is not covered here.
| Investor group | Capital | % of fund | Restricted? |
|---|---|---|---|
| Portfolio managers, GP capital | 18,000,000 | 7.20% | Yes, portfolio managers |
| Two analysts with trading authority | 4,000,000 | 1.60% | Yes, portfolio managers |
| Operations and finance staff, no trading authority | 2,000,000 | 0.80% | No |
| Investor employed by a broker-dealer | 5,000,000 | 2.00% | Yes, broker-dealer personnel |
| Other limited partners | 221,000,000 | 88.40% | No |
| Fund | 250,000,000 | 100% |
New issue profit for the year is 2.4 million. The classification of each investor comes from an annual questionnaire; the figures below assume it has been answered correctly.
Restricted share = capital of restricted persons ÷ total capital of the fund
Exempt if restricted share ≤ 10%
In Excel, with capital in B2:B6 and a Y/N flag in D2:D6: =SUMIF(D2:D6,"Y",B2:B6)/SUM(B2:B6).
Step 1: classify. Portfolio managers are people with authority to buy or sell securities for an investment adviser or a collective investment account, so the fund's own investment team is restricted. So are the two analysts if they can execute trades. Operations and finance staff without trading authority are not restricted merely because they work for the adviser. The investor who works for a broker-dealer is restricted as broker-dealer personnel.
Step 2: add up. 18.0 + 4.0 + 5.0 = 27.0 million of restricted capital.
Step 3: divide. 27.0 ÷ 250.0 = 10.80 per cent. The limit is 10 per cent, or 25.0 million, so the fund is 2.0 million over. Pro rata participation, which would give restricted investors 259,200 of the profit, is not available.
| Investor group | Pro rata (not allowed) | Capped at 10% | Full carve-out |
|---|---|---|---|
| Portfolio managers, GP capital | 172,800 | 160,000 | 0 |
| Two analysts | 38,400 | 35,556 | 0 |
| Investor employed by a broker-dealer | 48,000 | 44,444 | 0 |
| Operations and finance staff | 19,200 | 19,372 | 21,525 |
| Other limited partners | 2,121,600 | 2,140,628 | 2,378,475 |
| Restricted / unrestricted | 259,200 / 2,140,800 | 240,000 / 2,160,000 | 0 / 2,400,000 |
Under the cap, restricted investors share 10 per cent of each new issue, so each restricted dollar earns 92.59 per cent of what it would pro rata: a return of 0.889 per cent against 0.969 per cent for unrestricted capital. The 19,200 they give up is exactly what the unrestricted investors gain. Under a full carve-out the unrestricted investors earn 1.076 per cent. Either method needs a new issue sub-account in the fund's books, applied at every purchase.
| Change | Restricted share | Result |
|---|---|---|
| Operations staff wrongly counted as restricted | 11.60% | Fails, by more |
| Portfolio managers add 5.0 million | 12.55% | Fails |
| A 30.0 million unrestricted subscription | 9.64% | Passes |
| The broker-dealer employee redeems 5.0 million | 8.98% | Passes |
The ratio moves with every subscription and redemption, and the GP's own commitment is usually the largest restricted item. A fund that passes at the annual questionnaire can fail after a year-end GP top-up, so the test belongs at each new issue purchase, not once a year.
Cap or carve-out is a disclosure question too. Both allocations are permitted ways to stay within the rule, but they move money between investors. The method should be in the fund documents and applied the same way every time, exactly like any other allocation policy.
Divide restricted capital by total capital at every new issue purchase. At 10.80 per cent this fund must carve out, and the choice of method moves 19,200 or 259,200 of a 2.4 million profit between investors. The logic of fixing an allocation method in advance is the same as for deal allocations between funds, and the testing approach is set out in the free workbook and working documents for this book.
The main categories are broker-dealers and their personnel, finders and fiduciaries in the offering, portfolio managers, meaning anyone with authority to buy or sell securities for an investment adviser, bank, insurer, investment company or collective investment account, and certain owners of broker-dealers, with some immediate family members. In the illustrative fund the portfolio managers, two analysts with trading authority and an investor employed by a broker-dealer are restricted: 27.0 million of 250.0.
Yes, if it allocates the new issue so that restricted persons' combined interest in it stays within the limit. The usual methods are a full carve-out, where restricted investors receive nothing from new issues, or a cap at 10 per cent. On a 2.4 million new issue profit, a cap gives restricted investors 240,000 and unrestricted investors 2,160,000; a full carve-out gives unrestricted investors all 2,400,000.
Not merely because they work for the adviser. The portfolio manager category covers people with authority to buy or sell securities for the accounts. Operations and finance staff without that authority are not restricted on that ground. Counting them wrongly in the illustrative fund moves the restricted share from 10.80 to 11.60 per cent, and can force a carve-out on a fund that would otherwise pass.
This article is one calculation from The Private Fund Compliance Officer. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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