According to the first SEC Release (www.sec.gov/litigation/admin/2013/34-69090.pdf), from February 2008 through March 2011, Mr. Stephens worked as an independent consultant for Ranieri Partners LLC and actively solicited investors on behalf of private funds managed by Ranieri Partners’ affiliates. In return, he received transaction-based compensation totaling approximately $2.4 million (1% of capital commitments from investors). Stephens’ solicitation efforts included: (1) sending private placement memoranda, subscription documents, and due diligence materials to potential investors; (2) urging at least one investor to consider adjusting its portfolio allocations to accommodate an investment with Ranieri Partners; (3) providing potential investors with his analysis of Ranieri Partners’ funds’ strategy and performance track record; and (4) providing potential investors with confidential information relating to the identity of other investors and their capital commitments. By these actions, the SEC found that Stephens engaged in the business of effecting transactions in securities without first being registered as a broker or dealer or associated with a registered broker or dealer.
In a second Release, the SEC also announced a settlement against Ranieri Partners and Donald W. Phillips, its then Senior Managing Partner (www.sec.gov/litigation/admin/2013/34-69091.pdf). This second SEC Release said that Ranieri Partners and Mr. Phillips aided and abetted Stephens’ violations by providing him with key documents and information related to Ranieri Partners’ private equity funds and failing to take adequate steps to prevent Stephens from having substantive contacts with potential investors.
In settling the SEC’s charges, Ranieri Partners agreed to pay a penalty of $375,000 and Phillips agreed to pay a penalty of $75,000. The settlement said that Stephens “shall pay” disgorgement of $2,418,379.20 and prejudgment interest of $410,248.75, but then waived payment of such amounts based upon his sworn representations in his statement of financial condition. Similarly, the SEC elected not to impose a penalty based on such representations. However, Stephens agreed to be barred from the securities industry and his reinstatement, if he applies, can be conditioned on a number of factors, including payment of the disgorgement previously waived.
This settlement could be a very significant development if it marks a new area of focus for the SEC Enforcement Division. The agreement between Ranieri Partners and Stephens reveals an attempt by the parties to limit Stephens’ activities in such a way that he would qualify for the so-called “finders” exception to the broker-dealer registration requirement, e.g., stating that he would merely introduce investors to Ranieri Partners and not solicit investments, but his compensation arrangement was clearly outside the scope of the narrow finders exception. Not only did Stephens actually engage in solicitation, but he was compensated on a per-investment basis.
The finders exception is a creature of several SEC No-Actions Letters issued by the SEC staff over many years. It is not an easy task to reconcile all the No-Action Letters to create clear guidance, but one point is consistent throughout all the letters: the exception is not available if the party seeking to rely on the exception is paid a commission on sales or is otherwise compensated on the basis of the amount invested.
The issue of broker-dealer registration goes beyond contractors and affects fund managers directly in situations where fund managers do not use a registered broker-dealer to solicit investors. The first question is whether the fund manger has an ownership interest in the fund. If so, the fund manager’s employees and representatives may be covered by the “issuer” exemption if they meet certain requirements. The definition of a “broker” in the 1934 Act is any person engaged in the business of effecting transactions “for the account of others”.. Rule 3a4-1 under the 1934 Act sets forth a non-exclusive safe harbor under which the representatives of an ”issuer” will not be considered to be acting as brokers if they comply with the conditions of the rule. Those conditions prohibit the receipt by the representatives of transaction-based compensation in connection with the sale of securities and the safe habor is not available if the representatives are “associated persons” of a broker-dealer. The representatives must also have clean regulatory records and be free from so-called “statutory disqualifications.” Briefly, each representative must meet one or more of the following requirements under Rule 3a4-1 in connection with offers and sales to prospective offerees:
To complete the picture, registration as an investment adviser is not an exception to the broker-dealer registration requirement and limiting sales to private placements does not create an exception to broker-dealer registration. It is also clear that soliciting investors and then executing the documents through an independent registered broker-dealer will not address the issue. Indeed, it could create problems for the broker-dealer because of FINRA guidance on who is considered a “representative” of the broker-dealer and therefore must be registered as such.
A potentially larger issue that the SEC did not mention in its releases is the right of rescission on the part of investors if they lose money on securities that were sold to them by a party that was not registered as a broker-dealer but was required to be registered. This risk, as well as the risk that the SEC Enforcement Division might now be focused on private investment funds, suggests that fund managers should review their capital-raising practices.
ROGER WIEGLEY is an independent consultant and attorney with over thirty years of experience, including 16 years at major Wall law firms and 10 years in-house at financial services firms. He specializes in corporate transactions, financial services (securities, broker-dealer regulation, banking and insurance) and general commercial matters.
Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Roger D. Wiegley. This work reflects the law at the time of writing March 2013.