Byline: Arthur Weissman, Industry Fintech
A third-party administrator (TPA), sometimes referred to as a fund administrator, plays a mission-critical role as an independent party for alternative investments to ensure compliance in securities transactions. In these transactions, there are usually three key players: the Issuer (which is the company or firm raising money), the Investor, and sometimes a registered intermediary.
While intermediaries can be licensed broker dealers or investment bankers, their involvement tends to increase costs and add complexity to deals. Consequently, most funds, private deals, or alternative investments opt for a third-party administrator instead.
The primary responsibilities of a third-party administrator is to be an independent firm that ensures regulatory compliance, maintains books and records and provides investor support. This includes overseeing investor onboarding and reporting obligations among other tasks which vary depending on the agreement with the fund or deal they are serving. They may also extend their services to provide various back-office functions like managing payments correctly, conducting background checks on team members, and vendor management.
It is important to highlight that a third-party administrator’s allegiance lies with representing the entity and hence the investors' interests, despite being hired by the manager of the entity making the deal, since they are compensated from the deal's expenses—comparable to legal fees or consultant costs. They operate based on directives laid out in operating agreements or limited partnership agreements which govern their actions whether receiving instructions from fund managers or addressing investors' queries.
The core function of this role does not involve making judgment calls or mediating between parties. Instead, it centers on diligently following the stipulations set forth in pre-existing agreements and upholding regulatory standards for the duration of their involvement. By doing so, every action is confirmed to be within required parameters and consistent with the agreed-upon terms, thereby providing transparency in securities transactions.
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Maintaining Operational Flow and Compliance in Securities Transactions
As a third-party administrator our relationship with an investor starts from the moment they decide to invest. The initial step involves collecting the signed subscription agreements, which may be facilitated by attorneys chosen by the investors themselves. This marks the beginning of an investor’s onboarding process, which includes verifying their identity and confirming compliance procedures such as Anti-Money Laundering (AML) , Know Your Customer (KYC) procedures, and OFAC, Office of Foreign Assets Control.
The assessment of an investor's suitability for certain investments, however, is still the responsibility of the Issuer of the offering. A third-party administrator can help to collect and organize suitability information to assist issuers in making informed decisions regarding their investors.
It is crucial to distinguish the role of a third-party administrator from that of law firms which are involved in fund formation or deal structuring. Law firms are primarily engaged in preparing offering documents such as subscription agreements, setting up structural frameworks for deals based on managers' requirements, and ensuring these arrangements include appropriate risk disclosures compliant with regulatory standards.
Form D and Blue-Sky Filings
Once an investment is made, there are two significant compliance tasks: Form D filings and Blue Sky filings. Despite common belief, neither requires legal expertise to complete. Form D filings are required for most offerings under Regulation D and can be done directly through a government system online — a process we handle on behalf of Rastegar without necessitating law firm intervention.
Similarly, Blue Sky filings involve registering offerings state-by-state depending on where investors reside or might consider investing. Like Form D filings, this task does not demand legal training but rather an understanding of how to accurately fill out necessary forms and adhere to renewal schedules as required by each state’s regulations.
By executing these critical steps efficiently and accurately, we ensure not only regulatory compliance but also smooth operational flow between the issuer, their investors, and the relevant legal frameworks governing securities transactions.
Independence Matters
A crucial differentiation lies in our ability to act independently on behalf of both investors and issuers without conflict. This independence plays a significant role in why every deal should consider incorporating a third-party administrator. Law firms represent the fund itself; thus, their lawyers cannot interact directly with investors without having the issuer or manager present during such interactions due to their obligation towards representing the entity’s interests solely.
Consequently, if an investor wishes for direct communication with these legal representatives about specific matters concerning their investment, they would need their own legal counsel involved in these discussions.
On the contrary, third-party administrators benefit from an independent stance that serves both investors' and issuers' interests without any biases towards one party over another.
Blue Sky Filings
When discussing blue sky filings within the scope of a Regulation D 506(c) offering, the details can be a little tricky. There has been a major change recently with the launch of an online platform that aids in filing for many states, albeit not every single one. Essentially, when you embark on a 506(c) offering, you are effectively making your offer nationwide all at once.
There are several approaches to managing this comprehensive scope. One method involves using this online system to file for those states that participate in the portal. For those that do not, approximately ten at last count, manual submissions directly to each non-participating state become necessary. Also, certain offerings may strategically choose not to accept investors from specific states to simplify or minimize the workload associated with Blue Sky filings across the board.
Despite individual state filings not being overly expensive on their own, when aggregated across fifty states, costs can escalate rapidly - ranging from a few hundred to a couple of thousand dollars per state. This financial consideration holds true even if potential investment from some of those states seems unlikely.
Typically, lawyers work closely with managers during the initial stages of setting up an offering. They meticulously outline what regulatory requirements must be met on a state-by-state basis for Blue Sky compliance as part of this preparatory process.
Are Escrow Accounts Mandatory?
As a result of the ongoing CrowdStreet fiasco, escrow accounts are a big topic of discussion in the world of TPAs, as well as the broader commercial real estate space. Escrow accounts are not universally mandatory but they become necessary under specific conditions.
For instance, if a fund sets a preliminary financial goal — say, not proceeding with any closing until $10 million in commitments — then escrow accounts come into play to safeguard these initial funds. Additionally, escrow may be employed for anti-money laundering purposes, ensuring due diligence before funds are accessible by managers or issuers.
Why Segregate Investor Funds?
We firmly stress that investor funds should be segregated from immediate managerial access. This setup does not imply that the managing entity lacks ownership over the assets; rather, it strategically restricts direct withdrawal capabilities to mitigate unauthorized fund distributions or expenditures without oversight.
What Constitutes an Escrow Account?
Although often thought to merely represent a type of bank account, true escrow accounts embody a distinct legal and operational framework. A genuine escrow account involves setting up a segregated bank account for the fund or deal wherein authorized users are designated and the bank takes on certain liabilities associated with releasing funds – liabilities most banks prefer to avoid due to unique regulatory requirements and inherent risks when dealing with securities transacitons.
This challenge has led many TPAs to offer what can be termed as "administrative accounts." These function similarly by allowing investment capital to be held in dedicated accounts managed by a TPA without issuer or manager co-mingling of funds.
Following fulfillment of predefined conditions or upon reaching closing stages, the TPA can then either transfer these accumulated resources directly to the entity’s official banking channel or manage them in situ per client preference. This includes the ability to integrate expense reimbursement mechanisms alongside payable and wire transfer systems directly into this administrative hub.
These administrative accounts deliver essential safeguarding features similar in purpose to a traditional “escrow” account- monitoring and administrating outbound cash flows according strictly to terms set out within operating agreements or LPAs while ensuring accurate record-keeping for seamless integration into ongoing financial reporting.
Why You Should Never Invest in Any Private Deal Without a TPA
The idea of engaging in an investment without the level of oversight provided by a TPA is akin to driving without insurance or attempting to self-diagnose a serious illness. Essentially, it is a risky endeavor that bypasses crucial safeguards meant to protect investors and ensure transparency.
Two Reasons Why Entities Might Avoid TPAs
There are two main reasons an entity might choose not to engage a third-party administrator: cost concerns or a desire for privacy over operations. Both reasons are concerning but for different reasons.
1. Expected Cost Savings
Considering the relatively low expense associated with third-party administration compared to the overall budget of most deals, opting out to save costs can be short-sighted and exposes investors and the deal itself to unnecessary risks.
2. Desire to Avoid Oversight
Similarly alarming is when entities avoid third-party oversight simply because they prefer their operations to go unmonitored—this could be seen as a significant red flag signaling potential issues with how investor funds are managed.
At its core, involving a TPA is about operational integrity rather than just fulfilling legal liabilities or responsibilities. While managers and issuers remain liable for their actions regardless of hiring third-party services (including legal or accounting support), relying solely on internal capabilities can lead to gaps in compliance, knowledge, or execution—even if the intent and effort are there.
The presence of a third-party administrator enhances the investor experience by providing an independent resource for queries, issues, or reassurances needed throughout the investment lifecycle. This access ensures that even when fund managers are preoccupied with strategic tasks essential to achieving project objectives—often the case when communications seem scarce—investors have a reliable touchpoint ensuring procedural adherence and transparency.
Beyond Big Funds: The Universal Need for Fund Administration Services
Issuers and managers have a lot on their plates. They are out there executing, managing, and fulfilling their responsibilities. Often, they simply do not have the time to respond to investors or other stakeholders immediately. Without a third-party administrator, an investor might not understand why their messages aren’t promptly returned.
They might leave a message on Monday and not receive a callback until the end of the week due to the manager's travel or meetings. Investors start worrying when there is silence on the other end—this worry can quickly escalate from mild frustration to anxiety and even fear, altering their perception of the investment relationship.
Having a third-party administrator in place changes this dynamic significantly. Although it is not our role to act as salespeople or directly resolve investors' problems, our mere availability provides reassurance. Knowing that we are accessible can prevent an investor's initial concern from snowballing into full-blown panic over unreturned calls.
Why Some Fund Managers Lack TPA Services
There is another reason why fund managers and sponsors may not have utilized TPAs: they simply might not be aware of them or understand their accessibility for various deal sizes.
Traditionally, fund administrators were thought necessary only for large-scale funds managed by giants like Blackrock or Blackstone. What is not widely recognized is that these services are beneficial across all scales of operations — including startups and SPVs (Special Purpose Vehicles). Unfortunately, most large fund administrators set minimums that exclude smaller deals from utilizing their services due to perceived insufficient profitability.
Recognizing this gap in the market led us at IFT (Industry Fintech) to tailor our offerings specifically towards supporting this underserved segment. We have designed our business model to accommodate deals and funds that would not meet traditional administrators' criteria—essentially democratizing access to high-quality third-party administration for entities of any size.
Our initiative ensures every company can find cost-effective administrative support equipped with advanced technology capable of seamlessly performing required tasks regardless of whether they are raising hundreds of thousands or billions of dollars.
Why a Fund Needs to Work With a TPA
To sum up, third-party administrators are indispensable in ensuring investment security and operational transparency within securities transactions. Acting independently, they bridge essential gaps between issuers, intermediaries, and investors—enforcing compliance, facilitating smooth communications, managing detailed administrative tasks, and protecting investor interests throughout every step of a deal's lifecycle.
While upholding legal standards and streamlining processes across multiple aspects of investment dealings, they significantly enhance both investor satisfaction and confidence in financial undertakings’ integrity—ultimately benefiting all parties involved in securities transactions by making these processes more streamlined, comprehensible, and trustworthy.
