Prime Group Holdings LLC, a private equity firm based in Saratoga Springs, NY, has agreed to pay $20.5m to settle US SEC charges related to disclosure failures, the regulator said on Tuesday.
Prime Group failed to adequately disclose millions of dollars that were paid to a real estate brokerage firm that was owned by its CEO. Prime Group agreed to pay a $6.5m civil penalty and more than $14m in disgorgement and prejudgment interest to settle the charges.
According to the SEC’s order, Prime Group launched an investment fund in 2017 to purchase self-storage real estate properties.
The order found that the fund mostly relied on deal teams comprised of Prime Group’s employees and independent contractors to find and acquire “off-market” properties. The deal teams’ costs and compensation, as well as other expenses of Prime Group’s operations, were paid, in part, from a 3% brokerage fee the fund paid on the deal teams’ acquisitions.
The order found that the fund paid these brokerage fees to a real estate brokerage firm that was wholly owned by Prime Group’s CEO, making the brokerage firm an affiliate of Prime Group.
The new rules usher in significant changes to the regulatory landscape of the private funds industry.
As a result, Prime Group made misleading statements in the fund’s offering materials, including its limited partnership agreement, private placement memorandum, and due diligence questionnaires, concerning fees and conflicts of interest, because it failed to adequately disclose that an affiliate would be receiving these real estate brokerage fees. Between 2017 and 2021, the affiliated real estate brokerage firm received nearly $18m in brokerage fees at the closing of the fund’s property acquisitions, the SEC said.
“Funds, including those that invest in alternative asset classes, must ensure that their offering materials contain clear, accurate, and adequate disclosures,” said Osman Nawaz, Chief of the SEC’s Enforcement Division’s Complex Financial Instruments Unit. “In particular, information related to payments made to affiliates, and the potential conflicts of interest embedded in such arrangements, is critical to investors’ decisions.”
Violated Section 17(a)(2)
The SEC’s order finds that Prime Group violated Section 17(a)(2) of the Securities Act of 1933.
As the key enforcement provision of the 1933 Act, Section 17(a) prohibits fraud and misrepresentations in the offer or sale of securities. Section 17(a) is similar in many respects to Rule 10b-5, but Section 17 is broader because claims under Section 17(a)(2) and (a)(3) may be based on negligent conduct, while Rule 10b-5 claims require proof of scienter or willful misconduct.
The SEC continues to rely on Section 17, bringing a settled action against the Greenbrier Companies Inc. and its founder and former CEO in March for failure to disclose in the company’s proxy statements perks provided to Furman and other Greenbrier executives. The SEC’s settled order charged that Greenbrier and Furman were negligent under Section 17(a)(2) and (3) of the Securities Act of 1933, among other violations.
“Funds, including those that invest in alternative asset classes, must ensure that their offering materials contain clear, accurate, and adequate disclosures.”Osman Nawaz, Chief, SEC Enforcement Division Complex Financial Instruments Unit
Also in March, the SEC also brought a cyber incident disclosure-related enforcement action against Blackbaud Inc., a South Carolina-based cloud-computing company, for filing what the SEC said was a misleading 10-Q that omitted critical information about the cyber-criminal’s access to personal data such as social security numbers and usernames/passwords. The SEC’s order brought settled negligence, disclosure, and internal controls charges, alleging that Blackbaud violated Sections 17(a)(2) and (3) of the Securities Act.
One reason why this case is interesting is because the SEC drafted new rules just two weeks ago to overhaul the $18trn private fund marketplace in ways that will have an impact on this fast-growing sector.
The Commodity Futures Trading Commission joined the SEC on the proposed amendments insofar as it pertains to those funds that also are registered with that agency as a commodity pool operator.
The new rules revolve mainly around a disclosure form called “Form PF,” adding more transparency to these funds’ quarterly performance and fees charged to investors, while also barring some investors from getting preferential treatment over redemptions and portfolio exposure.
The rules also require private funds to perform annual audits.
Despite being less sweeping than originally considered at the proposal stage, the new rules usher in significant changes to the regulatory landscape of the private funds industry, and managers of private funds should review their current policies and disclosure statements to determine whether changes need to be implemented, including regulatory technology upgrades or additions, plus prepare for increased scrutiny over the safety and security of client assets.