In a recent enforcement action, the SEC found that an investment adviser was in violation of the investment adviser registration requirements under Section 203(a) of the Investment Advisers Act of 1940 (In the Matter of Penn Mezzanine Partners Management, L.P., Release No. IA-3858). The adviser and a related non-registered investment adviser both claimed to be exempt from registration under the Advisers Act. However, the SEC determined that the two advisers were under common control, were not operationally independent of each other and, therefore, should be integrated as a single investment adviser to determine if registration was required. Applying the integration test, it was determined that neither the adviser nor its affiliate was exempt from registration. Prior to this, the adviser had filed as an exempt reporting adviser under Section 204(a) of the Advisers Act as its only clients were private funds with assets under management of less than $150 million. The affiliated adviser claimed that it was exempt from registration as its clients were solely venture capital funds. By applying the integration test, the advisers were deemed to be operationally integrated.
The SEC determined that the two advisers should be integrated for purposes of determining whether registration was required by noting that not only were the advisers under common control, but they had several overlapping employees and associated persons, including those persons who provided investment advice to clients on behalf of both advisers. In addition, the advisers had significant overlapping operations without policies and procedures designed to maintain separation between the operations for the two advisers. Finally, there were inadequate policies and procedures in place to protect client information from each other.
The advisers agreed to the issuance of the SEC’s cease and desist order and a censure and has already taken steps to reorganize operations and separate investment advisory functions between the two organizations.