Advisors Engage in Prohibited Transactions While Awaiting Exemption Order
The Investment Company Act contains a number of provisions which limit, restrict or prohibit registered entities from participating in certain types of transactions. In some instances, the provisions give the Commission the authority to grant an exemption. It would seem prudent if a request is made for an order granting an exemption to wait for the ruling and, if it obtained, comply with its directives. That is not always the case, however. In the Matter of Garrison Investment Group, LP, Adm. Proc. File No. 3-19452 (September 13, 2019).
Respondents Garrison Investment and Garrison Capital Advisers LLC are each registered investment advisers. The private fund clients of GIG invest in debt securities and loans of U.S. based firms. The investments are allocated among the funds based on their investment mandate. If the firm does not have the capital to fund the investment, third party co-investors are sought. Typically, the co-investors’ participate through two GIG affiliates. At one point those vehicles were owned by one of the private funds. Later an affiliated special purpose vehicle was used.
On November 21, 2012 Respondents filed an application with the Commission requesting an order that would permit GIG’s Sole Client, a publicly-listed business development company, to participate in certain commercial loan transactions with the private funds and co-investor. While the application was pending, Sole Client participated in nine co-investment transactions. In each the borrowers paid an origination or closing fee that was distributed pro-rata among the lending entities based on the percentage each contributed to the commercial loan. The private funds and Sole Client each received their pro-rata share. The transactions were originated by GIG.
By effecting transactions that involved the business development fund client and advisory affiliates as joint participants, Respondents engaged in prohibited transactions. Investment Company Act Rule 17d-1 prohibits any affiliate of a registered investment firm from participating with the registered company in or effecting any joint enterprise, arrangement or profit-sharing plain unless an order is first obtained from the Commission. Here the agency had not issued such an order prior to the transactions.
On December 11, 2014 Respondents submitted their final Application for an order to the Division of Investment Management. It stated in part that all “existing entities that currently intend to rely on the Order have been named in the applications.” Not included, however, were the co-investment vehicles. The application also did not state that GIG would receive upfront fee revenue from the transactions.
On January 12, 2015 the Commission issued the Co-Investment Order that permitted the parties to participate in joint transactions. The transactions were limited to the terms of the orders. One condition limited the type of compensation that could be received. Here that limitation was disregarded. Later the CCO discovered the non-compliance and instituted remedial action. GIG also violated the custody rule because when it first registered with the Commission since it failed to conduct a surprise exam. The Order alleges violations of Investment Company Act Sections 57(a) and 34(b) and Rule 17d-1 as well as Advisers Act Section 206(4) and Rule 206(4)-2.
To resolve the proceedings Respondents consented to the entry of a cease and desist order based on the sections and rules cited in the Order and to a censure In addition, Respondents will pay, on a joint and several basis, a penalty in the amount of $250,000.