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manager is the possibility that it may incur aiding and abetting liability for the marketer’s underlying violation, among other things.


Recent developments, including relaxed statutory and judicial standards for establishing aiding and abetting liability, are likely to encourage the SEC to bring more of such enforcement actions in the future. For instance, in In the Matter of Visionary Trading LLC, the SEC charged a manager and a registered broker-dealer with willfully aiding and abetting and causing an unregistered broker-dealer and its employees to violate the Exchange Act.


On the other hand, some recent case law suggests that the aiding and abetting charge in the Ranieri case and in other cases will not always apply. For example, in the Wexler v. KPMG LLP case a fund investor who lost his investment in the Madoff Ponzi Scheme brought suit against the fund manager. The New York Supreme Court dismissed the aiding and abetting claim, stating that there was no evidence the fund manager substantially assisted the fraud.


However, the Wexler case may be distinguishable on its facts. The fund manager in Wexler may have been unaware of the Madoff fraud since that is a fact intrinsic to a particular entity or person that the manager may or may not discover. In contrast, it may be more difficult for a fund manager to validly claim that it is unaware that, as a general rule, fund marketers are required to register as broker-dealers or qualify for a clear exemption from registration.


Improbable exemptions Although there is a possible safe harbour, known as the issuers exemption, in which certain associated persons (e.g., directors and officers) of the issuer (or certain affiliates) can participate in the sale of the issuer’s securities without being considered a broker, the exemption is inapplicable to most private fund marketers, mainly because it restricts them from being compensated based on their participation in the securities transaction. In order to qualify for the exemption, the associated person must satisfy three primary requirements and at least one of three alternative sets of conditions.


The primary requirements are that the associated person must not be: (1) subject to a statutory disqualification, as defined in Section 3(a)(39); (2) compensated in commissions; and (3) at the time of his participation an associated person of a broker or dealer. In addition to the three mandatory requirements, the associated person must satisfy one of the four criteria under Section 3a4-1(a)(4). The alternative set of requirements that may be most useful to fund managers are found in sub- clause (a)(4)(ii), which, in order to qualify, requires an associated person to: (i) have substantial other


duties than marketing securities; (2) have not been associated with a broker-dealer in the prior 12 months; and (3) to not participate in securities offerings more than once every 12 months. Fund managers may qualify for this exemption, but a full- time employee in a marketing department offering securities on a continuous basis is unlikely to do so.


Another possible safe harbour exists in what is known as the finders exception. Based on a handful of SEC staff no-action letters, it is generally thought that persons who do nothing more than introduce prospective investors to the issuer are “finders,” not “brokers,” and are not required to register. A finder is prohibited from negotiating the transaction or receiving commissions related to the amount of the transaction. While a few no-action letters support this position and the SEC has not formally withdrawn them, the SEC has been reluctant to create an official “finder’s exemption.” Many securities practitioners view the finders exception to be too narrow to have any practical utility.


The SEC has cautioned that persons who find investors for issuers, even in a “consultant” capacity, may still need to register as a broker depending on a number of factors, including whether: (1) the finder participates in the solicitation, negotiation or execution of the transaction; (2) compensation is related to the outcome or size of the transaction; (3) the finder is otherwise engaged in the business of effecting securities transactions; and (4) the finder handles securities or funds of others. A “yes” answer to any of these factors indicates that registration may be required.


This area of regulation is currently in a state of flux and it remains to be seen if and how the SEC will enforce the provisions requiring broker-dealer registration for private fund marketers. In his speech, Blass floated the idea of creating an exemption specifically for private fund marketing, but wouldn’t budge on extending the hypothetical exemption to unregistered employees being paid on commission basis.


Consequences of violating the requirements There are a broad range of consequences for failing to register in-house marketers as broker-dealers or using the services of an unregistered third party, and either of these violations can implicate the fund and its manager. The remedies available in an SEC enforcement action or private civil action include: the potential right of rescission on the part of investors under federal or state law; fines, disgorgement, injunctions and the suspension of some or all activity; potential reputational risks in the marketplace and negative publicity; and if any resulting disciplinary event reaches the level of a Rule 506(d) “bad act,” potentially losing the ability


to issue fund securities under Regulation D. The Exchange Act provides that a contract made in violation of the Act shall be void. If a purchase of fund securities through an unregistered broker- dealer is “rendered void, investors would then be entitled to demand rescission of their investment in the fund and the unwinding of their investment to the detriment of the fund, its investors and, of course, the fund adviser.” A private plaintiff seeking rescission of the contract under the Act bears the burden of proving the marketer was not registered and was required to be.


Such a rescission action must be brought within one year after the discovery that the sale was made in violation of the Exchange Act and within three years of such violation. The right to rescission applies to any purchaser in the transaction, and not just purchasers who had been located by unregistered marketers. In addition to the Exchange Act, many state statutes that provide for a right of rescission can be read broadly to apply against an issuer if the purchaser bought securities through a marketer who was required to be registered as a broker under state law, but was not so registered.


Violating the broker-dealer registration requirement has even broader consequences for issuers. If the SEC determines that a finder was an unregistered broker-dealer, the issuer may be restricted from using any and all future registration exemptions under the Securities Act. Moreover, use of an unregistered broker-dealer may subject the issuer to liability for fraud under Section 20(e) of the Exchange Act. The issuer could be liable under the theory that they aided and abetted the unregistered broker-dealer in violating the Act. With such liability, both the finder and the issuer could be subject to civil monetary penalties and disgorgement of profits and/or commissions.


Ranieri Partners illustrates the real-world consequences of an issuer using an unregistered broker-dealer. The SEC not only found that the unregistered broker had violated the Exchange Act by failing to register as a broker-dealer, but that Ranieri Partners had caused the violations by failing to oversee his activities, and that the then managing partner had willfully aided and abetted the brokers’ violations by failing to limit his activities. As part of the settlement, the violating broker agreed to be permanently barred from the securities industry and to pay disgorgement and prejudgment interest in excess of $2.8 million.


Moreover, Ranieri Partners agreed to a civil money penalty of $375,000 and to cease and desist from causing any future violations of the Act. The managing partner also submitted to a cease and desist order, agreed to a $75,000 civil penalty, and


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