The SEC settled public administrative proceedings against TL Ventures Inc., a venture capital fund adviser (the “VC Fund Adviser”) and Penn Mezzanine Partners Management, L.P. (the “Private Fund Adviser” and with the VC Fund Adviser, the “Advisers”) over findings that the Advisers should have been regarded as a single advisory organization in determining whether to rely on registration exemptions or register under the Investment Advisers Act of 1940 (the “Advisers Act”). This article provides selected highlights of the SEC’s findings set forth in the respective settlement orders for each Adviser (which neither Adviser has admitted nor denied).
Exempt Reporting Adviser Status
Beginning on March 29, 2012, each of the Advisers claimed an exemption from registration under the Advisers Act as “exempt reporting advisers.” The Venture Capital Fund Adviser claimed to be an investment adviser whose only clients are “venture capital funds” as defined under Rule 203-l(1) under the Advisers Act, and thus to be exempt from registration under Section 203(l) of the Advisers Act from registration as an investment adviser. In its March 2014 exempt reporting adviser report on Form ADV, the Venture Capital Fund Adviser reported regulatory assets under management of approximately $178 million. The Private Fund Adviser claimed its only clients were “private funds” representing less than $150 million in regulatory assets under management, and that it could therefore rely on the “private fund adviser” exempt from registration under Advisers Act Rule 203(m)-1 and Advisers Act Section 203(m). In its March 2014 exempt reporting adviser report on Form ADV, the Private Fund Adviser reported regulatory assets under management of approximately $51 million.
The settlement order states that “the facts and circumstances surrounding their relationship indicate that the two advisers were under common control, were not operationally independent of each other and thus should have been integrated as a single investment adviser for purposes of the applicable registration requirement and the applicability of any exemption. Once integrated, [the Venture Capital Fund Adviser and the Private Fund Adviser] would not have qualified for any exemption from registration and therefore should have been registered effective March 30, 2012.”
The settlement order cites the following in discussing the integration of the Advisers:
- The Venture Capital Fund Adviser and the Private Fund Adviser reported that they are under common control with each other.
- Various employees and associated persons of the Venture Capital Fund Adviser held ownership stakes in the Venture Capital Fund Adviser and in the general partner and management company entities of the Private Fund Adviser; among those, two persons, one of whom was a managing director of the Venture Capital Fund Adviser, held in the aggregate a majority ownership interest in the Venture Capital Fund Adviser and indirectly held in the aggregate more than a 25%, but less than a majority, ownership interest in the Private Fund Adviser.
- The Venture Capital Fund Adviser and the Private Fund Adviser had several overlapping employees and associated persons, including individuals who provided investment advice on behalf of both the Venture Capital Fund Adviser and the Private Fund Adviser. For example, two of the three members of the Private Fund Adviser’s investment committee, which had sole and exclusive authority to approve any investment by the Private Fund Adviser’s fund, were also managing directors of the Venture Capital Fund Adviser and were significantly involved in providing investment advice for the Venture Capital Fund Adviser.
- The Venture Capital Fund Adviser and the Private Fund Adviser had significantly overlapping operations and no policies and procedures designed to keep the entities separate.
- Marketing materials for the Private Fund Adviser made reference to the Venture Capital Fund Adviser and the Private Fund Adviser as being a “partnership” and referenced the Private Fund Adviser’s ability to leverage and benefit from this relationship, including outsourcing its back office functions to the Venture Capital Fund Adviser.
- Managing directors of the Venture Capital Fund Adviser who served on the Private Fund Adviser’s investment committee solicited potential investors for the Private Fund Adviser’s funds, including soliciting past investors in the Venture Capital Fund Adviser’ funds.
- Neither Adviser had adequate information security policies and procedures in place to protect investment advisory information from disclosure to the other.
- Employees and associated persons of the Private Fund Adviser routinely used their Venture Capital Fund Adviser email addresses to conduct business and communicate with outside parties about and on behalf of the Private Fund Adviser.
The SEC determined that after giving effect to this integration, the Venture Capital Fund Adviser could not rely on the venture capital fund adviser exemption because its clients were not solely venture capital funds and (b) the Private Fund Adviser could not rely on the private fund adviser exemption because the combined regulatory assets under management of the two Advisers exceeded $150 million. Accordingly, the SEC found that each should have registered with the SEC as March 30, 2012.
The SEC found that each of the Advisers willfully violated (i) Section 203(a) of the Advisers Act, which prohibits the use of any means of interstate commerce by an investment adviser that has not complied with the Advisers Act’s registration requirements or properly relied on an exemption and (ii) Section 208(d) of the Advisers Act which prohibits any person from doing indirectly, or through any other person, anything that would be unlawful for such person to do directly under the Advisers Act.
Each of the Advisers agreed to a censure and a cease and desist order. (The Venture Capital Fund Adviser, whose order also related to violations of the Advisers Act’s pay-to-play rule, as discussed here, agreed to a civil money penalty of $35,000 that appears to be at least in part attributable to the pay-to-play rule violations.) Each Adviser’s settlement order notes that the SEC considered remedial acts being undertaken by the Adviser, “including steps to reorganize operations and separate its advisory functions from the other Adviser, as well as the adoption of policies and procedures reasonably designed to ensure compliance with the applicable rules.” The SEC did not direct the Advisers to register.