SEC Brings Enforcement Actions Against Private Fund Advisers

April 9, 2013

In the past month, the Securities and Exchange Commission (“SEC”) demonstrated its continued scrutiny of private funds by announcing actions in which the SEC settled administrative and civil proceedings or brought charges against private fund firms related to the following activities:

  • Using a finder/placement agent that was not registered as a broker-dealer;
  • Restructuring funds to provide preferential liquidity rights to a large investor and failing to disclose the new structure to existing or prospective investors; and
  • Trading for private funds based on inside information.

These cases highlight the need for all private fund advisers to take a fresh look at their compliance policies and procedures, business practices, and supervisory processes to ensure they provide sufficient guidance to firm personnel on the regulatory obligations that must be met when carrying out the firm’s business activities.

Use of Finder/Placement Agent That Was Not Registered As a Broker-Dealer
In the SEC’s action against private equity firm Ranieri Partners LLC (“Ranieri”)[1] and one of its former senior executives, Donald Phillips, the SEC imposed a penalty against Ranieri and suspended Phillips from association with an investment adviser or certain other SEC-regulated entities for hiring an unregistered broker-dealer to solicit investors on behalf of two private funds managed by Ranieri’s affiliates. According to the SEC’s Order, Ranieri and Phillips, hired William Stephens as an independent consultant to introduce to Ranieri prospective investors for two private funds managed by Ranieri’s affiliates. The agreement reportedly provided for Stephens to find prospective investors for the funds in return for 1% of total capital commitments made by investors that Stephens introduced. 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. Based on these activities, the SEC found that Stephens unlawfully engaged in the business of effecting securities transactions in return for transaction-based compensation without being registered as a broker-dealer or associated with a registered broker-dealer.

The SEC found that Ranieri caused, and Phillips aided and abetted, the violations by Stephens. Although Ranieri and Phillips reportedly limited Stephens’ activities under the finder agreement to contacting prospective investors and arranging meetings with Ranieri personnel, Stephens engaged in other solicitation activities as described above. The SEC further found that Ranieri failed to adequately oversee Stephens’ activities or effectively limit his access to fund documentation. In addition, the SEC found that Phillips assisted Stephens’ solicitation efforts because Phillips provided Stephens with key fund documentation, and obtained knowledge of Stephens’ substantive communications with prospective investors, but failed to monitor or limit such activities.[2]

Advisers who use a “finder,” placement agent, or solicitor to seek investors for the funds they sponsor should consider whether that person needs to be, and is, registered as a broker-dealer. Advisers should also consider whether the adviser itself or any of its employees may need to register as a broker-dealer based on their marketing and solicitation activities. For additional information regarding broker-dealer registration considerations for private fund advisers, see OMM’s client alert entitled “SEC Staff Raises Broker-Dealer Registration Issues for Private Fund Advisers.”

Restructuring Funds to Provide Preferential Liquidity Rights To Large Investor

In SEC v. New Stream Capital, LLC, et. al.,[3] the SEC filed a complaint against hedge fund managers David Bryson and Bart Gutekunst and New Stream Capital, LLC, (“New Stream”), an unregistered investment adviser that managed a $750-plus million hedge fund focused on illiquid investments in asset-based lending. The SEC also charged New Stream Capital (Cayman), Ltd., an advisory affiliate of New Stream, Richard Pereira, New Stream’s former CFO, and Tara Bryson, New Stream’s former head of investor relations, for their roles in the scheme. A final judgment has been entered against Tara Bryson barring her from associating with any investment adviser, broker-dealer, municipal securities dealer, or transfer agent. The SEC’s action against the firm and other named firm personnel seeks an injunction, disgorgement, and civil penalties.

According to the SEC’s complaint, Bryson and Butekunst revised the hedge fund’s capital structure to appease their largest investor, Gottex Fund Management Ltd. (“Gottex”), by giving Gottex and certain other preferred offshore investors liquidation priority over other investors. They restructured following Gottex’s threat to pull its money out of the fund because a wholesale restructuring a few months earlier had created two new feeder funds and granted equal liquidation rights to all of the investors, thereby eliminating the preferential liquidation rights previously enjoyed by the feeder fund through which Gottex had invested. The complaint states that New Stream’s marketing department, led by Bryson, continued to use the old marketing materials after the firm restructured the fund to reinstate Gotex’s priority liquidation rights and give certain offshore investors the same rights. New Stream reportedly raised nearly $50 million in new investor funds using the materially misleading obsolete solicitation materials and failed to disclose the revisions to the capital structure to prospective investors whose interests were materially impaired by those changes. The SEC further alleged that New Stream misled existing investors in the two new feeder funds by not disclosing that New Stream had subordinated their positions in the capital structure. Finally, the SEC charged New Stream’s CFO with falsifying the hedge fund’s operative financial statements to conceal the new capital structure. Due to the financial crisis of 2008, New Stream and affiliated funds went bankrupt and the defrauded investors received substantially less than the amount that Gottex and other investors in its preferred class received.

Trading For Private Funds Based On Inside Information

In SEC v. Douglas F. Whitman and Whitman Capital, LLC,[4] the SEC settled insider trading charges against an unregistered hedge fund adviser, Whitman Capital, and its principal, Douglas Whitman (“Whitman”). The SEC’s complaint alleged that Whitman’s friend, Roomy Khan (“Khan”) obtained pending quarterly financial information about two separate public companies, Polycom and Google, before the companies announced such information to the public. Khan received this material nonpublic information from a senior executive at Polycom and from an employee of an investor relations firm retained by Google. Khan shared the information with Whitman, who then caused hedge funds managed by Whitman Capital to buy over 100,000 shares of Polycom and thousands of Google put option contracts based on the tip. The funds earned around $1 million in profits from the unlawful trading. The final judgment bars Whitman from the securities industry and orders him to pay over $1.8 million in disgorgement and penalties. In parallel criminal case, Whitman received a two-year sentence and a criminal fine of $250,000.

O’Melveny & Myers is available to advise registered investment advisers and exempt reporting advisers on their compliance obligations with respect to the engagement of solicitors or placement agents, insider trading policies and procedures, and supervisory processes. For questions or additional information regarding such regulatory obligations, please contact Heather Traeger at (202) 383-5232, Kris Easter at (202) 383-5364, or Matthew Cohen at (202) 383-5179.

[1] In the Matter of Ranieri Partners LLC and Donald W. Phillips (Mar. 8, 2013), Securities Exchange Act Release No. 69091, available at http://www.sec.gov/litigation/admin/2013/34-69091.pdf.  
[2] In a related action, the SEC imposed a penalty of approximately $2.4 million against Stephens for unlawfully engaging in broker-dealer activities without being registered or associated with a registered broker-dear. See In the Matter of William M. Stephens (Mar. 8, 2013).
[3] SEC v. New Stream Capital, LLC, New Stream Capital (Cayman), Ltd., David A. Bryson, Bart C. Gutekunst, Richard Pereira, and Tara Bryson, et. al. (Feb. 26, 2013), Litigation Release No. 22625, available at http://www.sec.gov/litigation/litreleases/2013/lr22625.htm.  
[4] SEC. vs. Douglas F. Whitman and Whitman Capital, LLC (Mar. 20, 2013), Litigation Release No. 22653, available at http://www.sec.gov/litigation/litreleases/2013/lr22653.htm.  


This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Heather Traeger, an O'Melveny partner licensed to practice law in the District of Columbia and Texas, Kris Easter, an O'Melveny counsel licensed to practice law in Texas, and Matthew Cohen, an O'Melveny associate licensed to practice law in the District of Columbia and California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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