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On Behalf of | Jul 10, 2014 | Securities and Compliance

Lewitas Hyman PC

Investment management firms should make the effort to segregate the operations of affiliated entities that avail themselves of the separate registration exemptions under the Advisers Act for Private Fund Advisers,[1] Venture Capital Fund Advisers,[2] Foreign Private Advisers,[3] and Family Office Advisers.[4] In two administrative proceedings issued June 20, the SEC determined that two affiliated advisory entities, each of which availed itself of separate exemptions from registration under the Advisers Act, were operationally integrated to the extent that they were both in violation of the distinct requirements of their respective exemptions.

Penn Mezzanine Partners Management L.P. (“Penn”) claimed to be exempt from registration as a Private Fund Adviser with less than $150 million in regulatory assets under management. TL Ventures Inc. (“TL”) claimed to be an exempt adviser solely to venture capital funds.

Common control of the two entities is not sufficient to invalidate the exemption. But the SEC stated in the Exemptions Release[5] that it would treat two or more separately organized but affiliated advisers who were also operationally integrated, as a single adviser. Such a determination by the SEC might require one or both of them to register. In the case of Penn and TL, the SEC identified the following contributory factors to the integration analysis:

  • While the two entities stated they were under common control on their respective exempt reporting advisory reports, the scope of common control, as described, was fairly extensive:
    • Various employees and associated persons of TL held ownership stakes in TL Ventures and the general partner and management company of Penn.
    • Of these, two MDs of TL who held a majority interest in TL also indirectly held between 25-50% of Penn.
  • There were overlapping employees and associated persons who provided investment advice to both entities, e.g., two out of the three Penn investment committee members with sole and exclusive authority to approve Penn investments, were TL MDs who also provided investment advice to TL.
  • Penn marketing materials referenced both entities as a “partnership” and Penn leveraged the relationship, e.g., outsourcing the back office to TL.
  • The TL MDs who served on Penn’s investment Committee solicited potential investors for Penn, even among past TL investors.
  • Penn employees and associated persons routinely used their TL email addresses to conduct business with third parties about and on behalf of Penn.
  • Neither advisory entity had adequate information barriers policies or procedures in place.

When integrated with TL, Penn’s regulatory AUM exceeded the $150 million cap and therefore Penn was not entitled to claim the Private Fund Adviser exemption. Conversely, when integrated with Penn, TL was not solely an adviser to venture capital funds and therefore TL was not entitled to claim the Venture Capital Fund Adviser exemption. Consequently the SEC determined that neither party was entitled to claim their respective exemptions.

Under the SEC settlement agreements with the entities, they were required to reorganize and separate their advisory functions and to adopt policies and procedures reasonably designed to comply with applicable rules. Neither party was assessed monetary penalties (though TL had to pay penalties in connection with “pay-to-play” rule violations). However, there will certainly be costs associated with the reorganization and compliance efforts required under the settlement agreements.

Investment advisory firms that have grown and expanded their product and client base over time, particularly in cases where the Advisory Act exemptions have allowed such firms to develop a business model with certain efficiencies and advantages, should take a close look at their operations to determine whether they would be susceptible to such integration analysis. Advisory personnel in affiliated, exempt advisory entities should be wary of wearing too many hats.

For more information concerning the above, please call Lewitas Hyman PC at (888) 655-6002.

[1] Advisers Act Rule 203(1).

[2] Advisers Act Rule 203(m)-1.

[3] Advisers Act Rule 202(a)(30)-1.

[4] Advisers Act Rule 202(a)(11)(G)-1.

[5] Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less than $150 Million in Assets Under Management, and Foreign Private Advisers, Investment Act Release No. 1A-3222.