Real Estate Manager Used “May” Language and Failed to Disclose a Related Party Fee

On September 5th, 2023, the Securities and Exchange Commission (“SEC”) settled an administrative proceeding with a real estate manager¹ concerning undisclosed brokerage fees paid by its fund to an affiliated deal sourcing entity.
The real estate manager settled to a violation of Section 17(a)(2) of the Securities Act of 1933 and agreed to pay a $6.5 million civil penalty and more than $14 million in disgorgement and prejudgment interest to settle the charges.

Brokerage Fees: The real estate manager created a deal sourcing affiliate that was comprised of both employees and independent contractors who cold called owners of target properties to identify acquisitions. The affiliate collected a 3% fee on closed transactions which was paid by the fund.
Lack of Disclosure: In investor meetings and in marketing materials, the real estate manager emphasized its low cost structure but never disclosed the 3% fee including in response to direct inquiries from investors.
LPA Authority: The fund’s Limited Partnership Agreement stated the manager: “… may, from time to time, engage any person … Person so engaged may be Affiliates of the General Partner or employees of Related Persons.”
- Analysis:
  - While the real estate manager’s Limited Partnership Agreement allowed it to hire affiliates, the language “from time to time” was deemed misleading because the related party affiliate was continuously engaged.
  - Authority granted to this manager by the LPA did not override the manager’s obligation to disclose a key practice.

SEC Disclosure Standard: The disclosure standard that the SEC utilizes is based on disclosure of all material facts² which often includes a certain amount of context. In this matter, the manager omitted and/or misstated at least two material facts: (1) that an affiliate was always hired to source transactions; and (2) the affiliate was paid a 3% fee on all closed transactions. Managers often evaluate their own disclosure using a more forgiving standard which sometimes may create significant regulatory risk.
“May” Language: The SEC almost always considers the frequency of conduct to be material. Therefore, disclosure that conduct “may” occur or occurs “from time to time” is not sufficient disclosure for something that’s a routine part of a business.

¹ Prime Holdings Group, LLC; Administrative Proceeding File No. 3-21602

² Review SEC Rule 206(4)-8 for a detailed example of the disclosure standard applied to registrants.