You may have heard of a mythical creature called a finder or hedge fund placement agent – somebody, not otherwise connected to the financial industry, who can help you with starting a hedge fund by introducing you to wealthy friends. In return for this informal assistance with hedge fund marketing, you would pay this finder a prearranged fee.
It’s all perfectly legal. The Securities & Exchange Commission allows it, and has since at least the early 1990s and probably since the late 1970s.
But few people have ever heard of it actually happening.
“I’ve never encountered a finder in my entire professional career,” says hedge fund attorney Ron Geffner, a partner with New York-based Sadis & Goldberg. “It’s a mythical being. It’s like a unicorn.”
Once upon a time
Such was not always the case. During the dot-com bubble, when starting a hedge fund first came into vogue, there were a lot of people with a lot of money and little idea of what to do with it. According to contemporary press reports, finders – also called placement agents – could provide names and phone numbers of acquaintances with money to invest, but had to steer clear of anything else resembling hedge fund marketing: making material, non-public disclosures; negotiating sales; preparing documents and so on.
There was probably never a plethora of finders involved in hedge fund marketing. Their role has always been eclipsed by broker-dealers governed by the Securities Exchange Act of 1934 who, assuming they see more than $25 million/year in volume, are registered with the SEC.
“Sometimes you can easily determine if someone is a broker. For instance, a person who executes transactions for others on a securities exchange clearly is a broker,” an SEC spokesman commented via email. “However, other situations are less clear.”
According to the SEC, “a number of factors,” which were not enumerated, govern whether or not a finder has to register with the SEC, and hedge fund marketing is one of those activities that the SEC looks at, as is serving as a placement agent for private equity. And they specifically call out anyone who puts “Consultant” on their business cards.
But what if a nice guy is simply trying to help out a friend who’s starting a hedge fund by providing the phone number of someone else who’s looking to invest in one? What if Mr. Nice Guy already made his money doing something else besides hedge fund marketing and has no interest in spending tens of thousands of dollars registering with the SEC, then spend weeks studying for the NASD Series 7 and Series 65 exams?
You’d think that the issue would have been settled by the leading financial minds who rule over Wall Street. But actually, it was settled by multi-platinum, Grammy-winning singer-songwriter Paul Anka.
“Suddenly, it’s hard to find”
In May 1991, Anka was approached by associates who owned the Ottawa Senators hockey team. They were looking to sell limited partnerships in two classes and, in addition to hoping he himself would buy a stake (he did), they were willing to pay him ten percent of any proceeds coming from his wealthy individuals whose names came out of his Rolodex. (Anka, originally from Canada, is a die-hard hockey fan.)
That up-front percentage is what’s really attractive to a fund.
“A finder takes a one-time fee and only makes money when money is raised,” says Andrew Schneider, managing partner of West Palm Beach-based portal site HedgeCo, who is skeptical that there are any finders still hovering around the industry. “A third-party marketer gets paid an ongoing fee for the life of the investment.”
Anka was assured that this was completely on the up-and-up and he wouldn’t have to go through the hassle of registration, because the SEC had previously reviewed a similar arrangement approving a finder’s fee for non-brokers referring friends to potentially purchase condos in Hawaii. Unconvinced, Anka’s lawyers requested and received from the SEC a no-action letter.
It’s unclear how successful Anka was at helping the Senators raise capital, but it is now a settled regulatory exemption with nearly 20 years of effect.
It goes far enough back – how quaint it is that it doesn’t refer to email addresses or web sites – that the SEC spokesman was unable to find the no-action letter in a government database and a reporter had to locate it in a legal text. The letter cites at least three precedents going back to 1978. But because nobody ever heard of Victoria Bancroft, John DiMeno or Carl L. Feinstock, the exemption is called “the Anka rule”.
Specifically, the letter indicated that the finder will not:
- Prepare financial data, sales literature or any other materials,
- Distribute such materials,
- Perform independent analysis of the sale,
- Engage in due diligence,
- Arrange financing,
- Provide advice or
- Actually, physically handle any of the money or shares.
Rather, Anka agreed to just introduce potential accredited investors to the Senators, tell them what the securities’ unit prices were and disclose his own personal interest – his own stake in the enterprise as well as his right to receive a finder’s fee.
“Accredited investor” is a technical hedge fund term: the kind of wealthy individual or well-capitalized institutions covered under Regulation D of the Securities Act of 1933 – exactly the kind of investor that anyone engaged in hedge fund marketing is looking for.
At a recent hedge fund marketing conference sponsored by HedgeCo, panelists discussed how the Anka Rule would be as applicable to investment companies as to any tenant-in-common arrangement, such as limited partnerships or condos.
As far as the SEC is concerned, then, using a non-registered, non-licensed finder is completely legal. So why would a finder, if one is around, relate most closely with, of all Anka’s four-decade catalog of hits, “Lonely Boy”?
It’s because the SEC doesn’t have the last word. State regulators might not necessarily accept such arrangements as kindly. The state-by-state patchwork of licensure requirements is difficult to navigate, and even the most business-friendly of states, Utah for example, have pushed back.
Those interested in starting a hedge fund with the money of friends-of-friends may be well advised to see what the specific state regulations are governing their own situations and those of their prospective finders and investors.
Otherwise our mythological finder, Mr. Nice Guy, needs to be very careful how he accepts his friends’ gratitude.