The Securities Exchange Commission (“SEC”) recently charged a Private Funds Adviser for violations of the Registration and Custody rules, specifically as they relate to integration doctrines.
This is the first SEC enforcement action in over ten years against an Investment Adviser for violations against the Integration Doctrine. The Integration Doctrine is set forth in Rule 152 of the Securities Act of 1933 and prevents the separating of single offerings into multiple offerings to take advantage of exemptions that would otherwise not be available if the offering was not divided.
It is also applicable to funds structured as single offerings but operating as part of a bigger entity.
ACP Venture Capital Management Fund, LLC, failed to register with the SEC on the premise that it met the qualifications for the “Private Fund Adviser Exemption.” However, the SEC found that the firm was integrated with an affiliate, Partners Capital Service Inc. and SEC Registered Investment Adviser, with which it had significant overlaps that overrode the firm’s qualification for exemption. The SEC concluded that the firm’s affiliation disqualified it from the registration exemption.
The Private Fund Adviser Exemption
A Private Fund advisor can be exempt from registration requirements if they meet the following qualifications:
- They ONLY manage Private Funds
- They have an AUM of $150M or less
The SEC found that ACP Venture Capital Management, LLC did not meet either of these qualifications because:
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The business had an affiliate that could not be recognized as a separate entity due to several significant overlaps, including:
- Shared office space
- Shared email and website domains
- Overlapping owners, managers, and advisory staff
- Integrated operations
- Absence of clear Policies and Procedures to ensure separation of the two entities
- The business (integrated) managed both funds and individual assets
- The business (integrated) had a combined AUM of $251M (ACP Venture Capital Management, LLC = $137M, Capital Partners Service Inc = $114M).
Failing to meet the qualifications for exemption while still operating under those exemptions constituted a violation of registration requirements. Additionally, the adviser was deemed to have violated the “Custody Rule” by failing to meet the requirements for annual examinations and audits, as it was operating as a non-registered entity. ACP Venture Capital Management, LLC settled without denial or agreement to the charges for a civil penalty of $45,000 and several remedial actions.
Implications
There are several key lessons to be learned from this enforcement action, the most important being that the SEC is paying attention.
It is imperative for Private Funds to perform due diligence and understand the structure and operations of any affiliates before integrating. Some questions to ask are:
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Is the business eligible for exemption?
- Does the adviser only manage Private Funds?
- Does the advisor manage $150M or less in AUM?
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Is integration with another IA beneficial?
- Is the combined AUM of both entities under the $150M threshold?
- Are the entities managing the same type of assets?
- Are either of the entities providing advisory services to individuals?
- Is there a clear separation of managerial and advisory personnel between the two entities?
- Are there operational overlaps?
- If so, are there Policies and Procedures in place that demonstrate the two entities are indeed separate?
What Does this Mean for Fund Managers?
Potential for Exemption Loss: VC Fund Managers that are operationally integrated with, or too closely tied into, a larger Registered Investment Advisor may find themselves unable to avail themselves of the private fund adviser exemption. For VC fund managers, the result is that if your firm invests in 𝗻𝗼𝗻-𝗩𝗖 𝗮𝘀𝘀𝗲𝘁𝘀 (𝗡𝗤𝗜𝘀) and shares key resources or personnel with another adviser, you may be forced to 𝗿𝗲𝗴𝗶𝘀𝘁𝗲𝗿 𝘄𝗶𝘁𝗵 𝘁𝗵𝗲 𝗦𝗘𝗖, even if you manage less than $150M in AUM.
Compliance Burdens: If a fund manager loses its exemption from registration, it MUST comply with the full gamut of SEC registration requirements including annual audits and/or surprise examinations under the Custody Rules established to protect fund investors.
Key Takeaways:
Separation is Key:
INTEGRATION CAN NEGATE YOUR EXEMPTION. If your firm is not properly separated from other entities, you could lose your exemption; resulting in significant compliance burdens and potential penalties, even if your fund assets are below $150M. VC Fund Managers should take proactive measures to ensure your operations, resources, and personnel are clearly distinct to stay compliant.
When evaluating your firm’s particular situation for potential issues, consider the following:
- Are ALL FUND ASSETS invested solely into venture capital?
- IF NOT, are you CLEARLY SEPARATING management and advisory personnel?
- Do you have and utilize SEPARATE BUSINESS INFRASTRUCTURE (e.g. email domains, phone systems, and addresses)?
- Have you established FORMAL POLICIES AND PROCEDURES to prevent information sharing or conflicts of interest between you and your non-affiliated firm (and do you follow / enforce them)?
Firms with Private Fund businesses are well advised to review their current business structure to ensure that they are not in violation of the SEC’s registration requirements.
For assistance with reviewing your Private Funds structure or if you are exploring new structures, please contact us at 619.298.2880 or email [email protected].
