Monthly Archives: March 2013

SEC Action Against Manager for Related Party Transactions

While this happened in the middle of last year, we thought it might be helpful to managers to review this particular case especially as registered investment advisers are currently in the process of updating Form ADV.

Overview of Case

On June 21, 2012, the SEC filed in action in the US District Court for the Northern District of California against Mark Feathers (“Feathers”) and Small Business Capital Corp. (“SB Capital”), Investors Prime Fund (“IPF”), and SBC Portfolio Fund (“SPF”). The SEC alleges that Feathers and SB Capital made material misrepresentations and omissions regarding both IPF’s and SPF’s investment activities. Feathers and SB Capital also allegedly violated broker-dealer registration provisions and created fraudulent management fees.

The SEC alleges Feathers and SB Capital used a Ponzi-like scheme to pay returns to investors. SB Capital allegedly misrepresented the portfolios of the funds at issue, the funds’ lending standards, the nature of the funds’ loans, and the existence of conflicts of interest between SB Capital and the funds. These misrepresentations appeared in advertisements in California publications, newsletters, and offering documents. In addition, SB Capital allegedly made transfers between IPF and SPF to increase management fees. Finally, the SEC claims that SB Capital never registered as a broker-dealer.

The SEC asserted causes of action under Section 17(a) of the Securities Act (prohibiting fraudulent interstate transactions), Section 10(b) of the Exchange Act and related rules (prohibiting the use of manipulative and deceptive devices in the buying and selling of securities); Section 15(a) of the Exchange Act (prohibiting unregistered broker-dealers from inducing the trading of securities); and Section 20(a) of the Exchange Act (creating liability for the person in control of an entity which violates Section 15(a) of the Exchange Act).

The SEC’s complaint is available here.

Takeaways for Managers

The alleged conduct included the following:

  • Never registering with the SEC as a broker-dealer.
  • Representing that the funds’ returns would be 7.5% per year;
  • When returns did not meet that threshold, using money from new investors to make up the difference;
  • Failure to disclose the use of investor money to pay SB Capital’s day-to-day expenses, conduct that was in direct conflict with materials provided to investors;
  • Stating that the funds would not make loans to SB Capital, when in fact they did;
  • Mischaracterizing the funds’ loan portfolios as secured, when in fact they were not;
  • Misrepresenting the audit procedures in place;
  • Causing IPF to purchase loans at a premium from SPF to generate management fees; and
  • Assuring investors SB Capital owed them a fiduciary duty, even though Feathers and SB Capital would cause the funds to engage in related party transactions to generate management fees.

The bottom line:

  • Broker-dealers should register with the SEC to avoid liability under Section 15(a) of the Exchange Act;
  • Be honest about the nature of the funds you manage, including the portfolios of the funds, the kinds of transactions the funds engage in, and how returns operate;
  • Be upfront with investors about potential conflicts and related party transactions; and
  • Take care that the materials you provide investors are accurate.


On the most basic level, Small Business Capital Corp. represents a warning to managers to not engage in fraudulent or exploitive conduct like taking advantage of conflicts of interest and related party transactions. More generally, it is a good reminder that providing truthful information to investors is paramount. The SEC approaches the anti-fraud provisions of the securities laws broadly. We recommend that managers have their attorney, in-house counsel or compliance consultant review all materials meant for distribution prior to distributing them, and that managers retain these materials and backup information in their files.


Cole-Frieman & Mallon LLP provides a full suite of legal and advisory services to hedge fund managers and the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

BEA Reporting for Fund Managers: the SEC is not the only regulator gathering investment-related data.

Background on the U.S. Department of Commerce, Bureau of Economic Analysis (“BEA”).

The BEA collects data on U.S. direct investment abroad, among other mandates. Its tools include Form BEA-11 (“BEA-11”) for U.S. persons that have ownership interests in foreign affiliates. Historically, these filings received almost no attention. Enforcement of the filing requirements was rare, but is expected to increase following the BEA’s announcement in May of 2012 that it would be more vigilant.  [Note: Enforcement penalties include civil and criminal fines and even imprisonment for failure to file.]

BEA-11 is due annually by May 31 for those who meet a two-pronged test. The filing is confidential and requires data points on employees, assets, expenses, share/interest structure and other financial information (much of it, such as imports and exports will be inapplicable to most fund managers).

Do I have to file?

The filing requirement is most likely to apply to larger U.S. fund managers (the term “Manager” includes U.S. managers, their principals, and any affiliated U.S. entities) that have full master-feeder structures, offshore blocker entities or other special purpose vehicles. The following events trigger a filing:

  • Meeting the below test, regardless of whether a Manager has been contacted by the BEA; or
  • If a Manager receives a letter from the BEA, it must either file if it meets the test, or submit a Claim of Not Filing (“Claim”). NB: A Claim is only required if the Manager is contacted by the BEA. Because the Claim contains much of the same information as required on BEA-11, we would not recommend filing it preemptively.

The First Prong – Reporting Thresholds:

Reporting is not required with respect to offshore affiliates where:

  • none of the following (each, an “Exemption Item”) exceeded $60 million for the offshore affiliate’s most recent fiscal year: (a) total assets, (b) sales or gross operating revenues excluding sales taxes and (c) net income (or loss) after provision for foreign income taxes; OR
  • the U.S. person’s interest in the offshore affiliate was acquired or established in the most recent fiscal year, and none of the Exemption Items exceeded $25 million for the affiliate’s most recent fiscal year.

The $60 million and $25 million thresholds are referred to as “Reporting Thresholds.”

The Second Prong – Ownership Level:

Filing is required of U.S. persons that own or control, directly or indirectly, 10 percent or more of an offshore affiliate’s voting securities (or equivalent). Consider the following examples (see note below):

  • Offshore Limited Partnerships (“LPs”): generally, LP interests in a master fund are structured as non-voting. Accordingly, its feeders would not be U.S. reporters. In contrast, the fund’s general partner would be considered to own 100 percent of its voting securities, and would be a U.S. reporter.
  • Offshore Companies: voting rights will vary depending on the share class in question. A company that has one class of shares, all with voting rights, may provide enough dilution such that a Manager owns less than 10% of total shares. On the other hand, it is common to issue one class of voting shares to the Manager, and another class of non-voting shares to outside investors (similar to the structure of a LP). In such a case, the Manager would be a U.S. reporter.

[Note: While these examples will be helpful in identifying potential reporters within your structure, we recommend reviewing your offshore entities’ constituent documents to determine the nature of any voting interests and related provisions.]

Putting It All Together:

Remember that both prongs must be met to trigger the filing. We suggest starting your analysis by determining the amount of your AUM attributable to offshore affiliates (“Offshore AUM”); if it is less than the $60 million Exemption Item for total assets, it is likely that the offshore affiliates would be under the Exemption Items for income and revenue (i.e., performance gains or other income, if any) as well. If your Offshore AUM exceeds $60 million, proceed to the rest of the analysis to determine whether a filing is required.

Disclosure and Reporting Requirements Continue to Evolve.

Post-crisis, we have seen an increase in disclosure and reporting requirements, particularly for larger fund managers. BEA reporting highlights the fact that regulators other than the SEC collect data and can penalize those who do not file. We encourage you to stay in touch with your outside counsel, compliance consultants and other service providers who can keep you apprised of regulatory developments.


Cole-Frieman & Mallon LLP is a boutique hedge fund law firm focused on providing hiqh quality counsel for the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

Hedge Fund Events March 2013

The following are various hedge fund events happening this month. Please email us if you would like us to add your event to this list.


March 3-5

March 3-6

March 4

March 4

March 5

March 5-6

March 6

March 6

March 7

March 7

March 7

March 7-8

March 11

March 12

March 13-15

March 14

March 14-15

March 14-15

March 18

March 18-19

March 20

  • Sponsor: Shift Forex
  • Event: FXIC 2013
  • Location: New York, NY

March 20-21

March 21



Cole-Frieman & Mallon LLP provides legal services for hedge fund managers and other groups within the investment management industry. Bart Mallon can be reached directly at 415-868-5345.