When starting a hedge fund, one of the most important matters that the start up hedge fund manager needs to think about is how the initial investment capital is raised and from whom it is raised. Generally, initial investment in the startup hedge fund comes for the investment manager’s family, friends and those individuals with whom the startup hedge fund manger has had previous business dealings. But, what happens after those friends and family sources have been exhausted? Where does the fund manager go from here? Can he/she use brokers, finders, consultants, or third party marketers? Some of the questions that the start up fund manager needs to ask in this context are:
- Can the investment manager reasonably expect that the traditional securities broker will solicit the sale of the hedge fund interests that are not a product of their firm?
- or, more importantly, would a broker have “suitable clients” to whom he or she could reasonably offer a hedge fund investment where the hedge fund has no or a limited a track record?
- Also, can the so called “finder” “consultant”, or “third party marketer,” not registered as a broker, introduce investment to the startup hedge fund and receive finder’s fees?
Using the so called “third party marketers,” “consultants” and “finders,” none of whom are registered as brokers, has risks, among these being an SEC enforcement action. On March 8, 2013, the SEC announced the entry of an agreed order in which the SEC found that a third party consultant willfully violated Section 15(a) of the Exchange Act, which “requires persons engaged in the business of effecting transactions in securities to be registered as a broker or dealer or associated with a registered broker or dealer.” From 2008 to 2011, the so called independent consultant actively solicited investors for the private funds managed by the fund manager and was paid, as a fee, a percentage of the capital committed by investors introduced by the consultant.
Some of the actions undertaken by the so called independent consultant indicative of broker activity requiring registration, included:
- sending to potential investors private placement memoranda, subscription documents and due diligence materials that were provided to the consultant by the Fund Adviser;
- encouraging potential investors to invest in the private funds managed by the Fund Adviser;
- providing analysis of the Fund Adviser’s strategy and track record; and
- providing potential investors with confidential information related to the private funds.
The SEC also found that the fund manager aided and abetted caused the independent consultant’s violations which resulted in the entry of a cease and desist order as well as substantial civil penalties.
Back to Hedge Fund News and Articles