Whether they know it or not, managers of US hedge and private equity funds would have to register with the SEC as securities brokers in order to sell interests in their funds to outside US investors were it not for an obscure little rule called the “issuer exemption.”
Generally speaking, anyone in the US who buys or sells securities for the accounts of others has to register with the SEC as a securities broker. The “issuer exemption” enables employees of a private investment fund, for example, to market interests in the fund directly to new investors without becoming registered brokers. The exemption, however, is available only to those employees of an issuer whose “primary function” is not marketing fund interests to outsiders.
For any member of a private fund’s staff whose “primary function” is marketing fund interests to third parties, the “issuer exemption” is not available, so any dedicated internal marketer has no choice but to register with the SEC as a securities broker (and operate through a FINRA member firm — see Marketing Private Investment Funds). Any fund personnel who are paid bonuses based upon their success in raising capital for their funds are presumed to be primarily involved in marketing. The exemption is also technically unavailable to fund managers who are continually in the market for investors.
Now that Dodd-Frank requires managers of private funds holding more than $150 million in AuM to register with the SEC as investment advisers (see Uncle Sam Wants You!), the SEC wants to make sure that the staff of such funds adhere to the regulations applicable to selling securities as well as fulfill their fiduciary duties as investment advisers. Enforcement of the broker registration requirement for private fund personnel has not been a high priority for the SEC in the past, but the Chief Counsel of the SEC’s Division of Markets and Trading just highlighted it in a recent speech to the American Bar Association. Violations could result in costly penalties and investor rescissions.
Since only established funds can afford the luxury of full-time internal marketers, this surprise initiative from the SEC is clearly aimed at the upper end of the private fund industry. It also sends a message that the SEC is determined to get all of its newly-registered private fund managers on board with all applicable rules.
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About Hedge Fund Lawyer Stephen Bornstein
Stephen A. Bornstein opened his own law office in 2010 where he provides comprehensive general counsel services on a consultative basis to investment advisers, family offices and managers of hedge funds, venture capital funds, private equity funds and funds of funds. Stephen also advises asset managers and litigators in connection with securities investigations and lawsuits.
From 1984 to 2006, Stephen served as General Counsel and Executive Vice President of Bear Stearns Asset Management and, from 2006 through 2009, as a Senior Vice President of D. E. Shaw & Co. In 2012, he became a senior adviser to the boutique law firm of Tjong & Hsia. Stephen began his legal career at Willkie Farr & Gallagher in 1980.