The SEC issued a no-action letter on November 13, 2014 to Social Finance, Inc., indicating that it would not recommend enforcement action against Social Finance for its conduct as an intermediary in social impact bond (SIB) projects.
The basic concept underlying SIB programs, also sometimes called “pay for success” programs, is that private investors provide the financing for some social services program that has a specified goal, such as reducing the recidivism rate at a particular prison. The private investors are paid no return (and may not even be repaid their principal) if the stated goal is not achieved. On the other hand, if the goal is achieved, the investors are entitled to some return, which can be based on a sliding scale that corresponds to some measure of the program’s success. Social impact bond intermediaries are the companies that coordinate and oversee the projects, including by arranging the financing and managing service providers that will be providing the actual services that are intended to achieve the goal. This Forbes article has some good background on how social impact bonds work (and on Social Finance, which it describes as “the pre-eminent social impact bond intermediary worldwide”). SIB programs were pioneered in the UK, and now several U.S. states are experimenting with SIB programs and bipartisan federal legislation was introduced this summer, the Social Impact Bond Act, which would allocate $300 million in federal funding to SIB projects.
Social Finance’s Activities
Social Finance indicated in its request that its activities would include identifying investors who might be interested in purchasing LLC or limited partnership interests in special purpose vehicles that pool money for investment in SIB programs. The securities would be issued to accredited investors in private placements. The special purpose vehicle would deliver the funds to a service provider that would be tasked with performing the primary work. In its role as an intermediary, Social Finance would be involved in identifying particular initiatives that may be a good match for an SIB program, performing due diligence to understand the proposed intervention, projecting cash flows, assessing and monitoring service providers, selecting service providers, and working with an administrator on the distribution of funds to service providers. Social Finance would also have a role in “pricing and managing the risks of the SIB.” However, evaluation of whether the goal of an SIB program had been achieved, such that investors were entitled to a return, would be handled by an independent third party.
SEC No-Action Letter
Social Finance requested confirmation that the SEC would not recommend enforcement against Social Finance or its employees for violations of Section 15(a) of the Securities Act of 1933 (being engaged in the business of effecting transactions in securities without being a registered broker-dealer). The SEC agreed that it would not recommend enforcement. As usual, the SEC noted that its views should not be construed as evidence of any SEC position outside of the specific factual circumstances presented by Social Finance.
Assuming for purposes of the no-action letter that the investments in SIB projects were in fact “securities” within the definition of the Securities Act, the SEC noted the following significant factors:
- Social Finance intends to earn fees for its services, including intermediation management fees and service outcome fees. The management fees would compensate Social Finance for performance monitoring and management, quarterly reporting to investors, and answering investor questions. The outcome fee would provide a stated payment to Social Finance based on whether the goal of the SIB program has been met, as determnined by anindependent evaluator.
- The fees to be received by Social Finance, including any outcome fees, would not constitute compensation based on sales of securities, because the fees would be based on services performed by Social Finance or on the achievement of a positive social outcome, rather than on the number or value of securities.
- The “matching” of investors with SIB projects would constitute only a small portion of the larger portfolio of services provided by Social Finance.
- Social Finance would not handle investor funds or securities.
- Certain employees of Social Finance would serve as officers, directors, employees, or managing members of a special purpose vehicle, but their compensation would be fully paid by Social Finance rather than by the special purpose vehicle.
Note that although Social Finance has some assurance that it won’t be the target of enforcement action for violating Section 15(a) of the Securities Act, several states (including Minnesota) have enacted legislation that regulates, and requires the registration of, agents or finders in connection with the sale of securities in circumstances in which Section 15(a) is not implicated.