SEC Sanctions Finder as Unregistered Broker, Fund Manager for Aiding and Abetting
In events that will be of interest to many private investment fund managers and sponsors, the Securities and Exchange Commission (SEC) has settled an action against a consultant for acting as an unregistered broker in connection with soliciting sales of private investment funds. The SEC entered similar settlements with the fund manager and one of its principals.1 The Ranieri Partners andStephens enforcement actions make clear that the use of unregistered consultants or finders in connection with private investment fund sales—even in the absence of fraud or other misconduct—may expose not only the finder, but the fund manager and its principals, to financial and other penalties.
The SEC charged Ranieri Partners LLC (Ranieri), a private investment firm that invests primarily in distressed residential mortgages and real estate; its former senior managing partner, Donald Phillips (Phillips); and William Stephens (Stephens), an independent consultant hired by Ranieri, with various violations under the Securities Exchange Act of 1934. Specifically, Stephens was found to have acted as an unregistered broker in marketing interests in Ranieri’s funds in violation of Section 15(a) of the Exchange Act;2Ranieri was found to have “caused” that violation; and Phillips to have willfully aided and abetted and caused the violation.3
The SEC found that Phillips caused entities controlled by Ranieri to hire Stephens as an independent consultant to solicit investors for investment funds managed by Ranieri. At the time of Stephens’ hiring, Phillips claimed to have been “generally aware”4 of Stephens’ prior disciplinary history with the SEC.5 Stephens’ contract specified that Ranieri would pay him a commission equal to 1% of all capital commitments made to the Ranieri funds by investors introduced by Stephens.
Phillips claimed to have informed Stephens that (i) Stephens’ activities on behalf of Ranieri should be limited to contacting potential investors to arrange meetings with Ranieri principals, and (ii) Stephens was not permitted to provide private placement memoranda (PPMs) directly to potential investors, or to directly contact investors to discuss the merits and strategies of the Ranieri funds. However, according to the SEC, even though Phillips was responsible for coordinating Stephens’ (and other finders’) activities regarding contacting potential investors, he failed to provide any real oversight of Stephens’ solicitation activities.6
Despite Phillips’ alleged instructions to Stephens prohibiting the distribution of PPMs to potential clients, the SEC found that Phillips and other Ranieri personnel provided him with PPMs, subscription documents and other marketing materials (such as executive business plan summaries). Stephens did set up initial meetings with potential investors, during which Phillips made presentations regarding possible investments in the Ranieri funds. But on several occasions subsequent to those meetings, Stephens communicated on his own, both in person and via email, with these potential investors (and other persons associated with these potential investors) without any participation of Ranieri personnel. For example, Stephens sent PPMs and other written materials to those potential investors. He also sent potential investors confidential information containing the names of other potential investors, their anticipated capital commitments and expected dates of investment. Stephens also sent emails to potential investors promoting the likely “above market returns”7 of the funds being offered.
In settling the SEC’s claims against him, Stephens agreed to a permanent bar from the securities industry, and to pay disgorgement and prejudgment interest in the amount of approximately $2.83 million (which the SEC waived based upon Stephens’ sworn statement that he lacks the funds to pay). Ranieri agreed to a penalty of $375,000 and to a cease and desist order with respect to current and future violations of Section 15(a), and Phillips agreed to a penalty of $75,000, an identical cease and desist order, and a nine-month suspension from acting in a supervisory capacity in the securities industry.
This case may signal a broader focus by the SEC on the use of unregistered consultants and finders to solicit sales of private funds. Notably, the SEC took action not only against the finder, but also against the fund management company and one of its principals for not properly supervising the finder’s interactions with potential investors. Moreover, the case stands out as one in which a finding of a violation of the broker-dealer registration provisions was unaccompanied by any finding of fraud or other misconduct in connection with the relevant Ranieri fund offerings. Going forward, fund managers should bear in mind, first, that the payment of transaction-based compensation continues to be a red flag to SEC staff that broker-dealer registration may be required; and second, that contractual provisions or other formalistic instructions to consultants or finders purporting to place limits on their interactions with potential investors—especially if the sponsoring fund turns a blind eye to activity by a consultant that is contrary to such instructions—may not be sufficient to protect the firm and its principals from potential charges of causing, or aiding and abetting, violations of the broker registration requirements.
1 http://www.sec.gov/news/press/2013/2013-36.htm. As is typical in SEC settled actions, Stephens, Ranieri and Phillips—the respondents in the SEC settlement actions—consented to the settlement orders without admitting or denying the findings contained in the orders.
2 Exchange Act Release No. 69090 (March 8, 2013), available at http://www.sec.gov/litigation/admin/2013/34-69090.pdf.
3 Exchange Act Release No. 69091 (March 8, 2013), available at http://www.sec.gov/litigation/admin/2013/34-69091.pdf.
4 Exchange Act Release No. 69090 at 3.
5 In 2002, the SEC entered an order imposing on Stephens a two-year bar from associating with any investment adviser, as well as a $25,000 civil penalty, for violating the federal securities laws in connection with the investment of pension fund assets. Exchange Act Release No. 69090 at 2.
6 For example, Ranieri reimbursed Stephens in connection with travel and entertainment expenses for trips to meet potential investors, including for trips he took on his own without Phillips or any other Ranieri personnel. Exchange Act Release No. 69090 at 6.
7 Exchange Act Release No. 69090 at 4.
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