On September 5, 2023, the Securities and Exchange Commission (SEC or Commission) announced a settled Order Instituting Proceeding (Order) involving private equity firm Prime Group Holdings LLC (Prime Group). The Commission found that Prime Group failed to adequately disclose that it paid real estate brokerage fees to a brokerage firm that was wholly owned by Prime Group's CEO and was therefore considered an affiliate of the firm.

According to the Order, in 2017, Prime Group launched an over US$500 million investment fund (Fund) to invest in self-storage real estate properties and retained employees and contractors to source "off-market" real estate deals. These employees and contractors were funded, in part, through a 3% brokerage fee that Prime Group paid to a real estate brokerage firm that was wholly owned by Prime Group's CEO. The real estate brokerage firm, which the Commission found to be an Affiliate of Prime Group, was paid nearly US$18 million in brokerage fees between 2017 and 2021.

As part of its marketing and placement materials for the Fund, Prime Group disseminated a limited partnership agreement (LPA) with the following language (with emphasis added):

The General Partner may, from time to time, engage any person to render services to the Fund on such terms and for such compensation as the General Partner may determine, including attorneys, investment consultants, brokers, independent auditors and printers. Person so engaged may be Affiliates of the General Partner or employees of Related Persons.

The Commission found this disclosure to be inadequate, stating that "[a]lthough this section refers to 'Affiliates of the General Partner' merely being engaged 'from time to time,' the use of Affiliate. . . was an important component of Respondent's business model, and Affiliate received fees on the majority of Fund II's transactions."

The SEC also found answers to questions in the Fund's generic due diligence questionnaire (DDQ) to be misleading, as they denied the use of a broker and stated that all sourcing was done "internally." The brokerage fees also were omitted from customized DDQs sent by investors, which asked specifically about brokerage fees and affiliates.

The SEC found that Prime Group violated Section 17(a)(2) of the Securities Act of 1933, a securities fraud violation that can be based on ordinary negligence and does not require recklessness or actual knowledge. Avoiding a scienter-based charge (such as one under Section 17(a)(1) of the Securities Act of 1933 or Section 10(b) of the Securities Exchange Act of 1934) is critical to the continued operations of the Fund. That said, without admitting or denying liability, Prime Group agreed to pay disgorgement and prejudgment interest in excess of US$14 million and a civil money penalty of US$6.5 million. Notably, no individuals were charged in this matter.

While the responses in the DDQs certainly elevated the risk in this case, the SEC's approach to the language in the LPA is consistent with its current view on disclosures, which deems inadequate any disclosure of hypothetical fees or conflicts when the firm knows it actually does have that conflict. In other words, the SEC considers disclosures suggesting that a fund "may have a conflict" as insufficient in instances where a conflict clearly exists.

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