Do I Have to Tell Prime Broker About SEC Subpoena

Do I Have to Tell Prime Broker About SEC Subpoena

There’s no SEC regulation that says “you must notify your prime broker when you receive an SEC subpoena.” No rule, no statute, no explicit requirement. You could technically receive a subpoena, respond to it, and never mention it to your prime broker. The SEC isn’t going to fine you for that.

But here’s what will happen. Your prime brokerage agreement almost certainly contains provisions that create this obligation anyway. Representations and warranties about regulatory status. Material change notification requirements. Covenants about legal proceedings. The contract you signed with your prime broker probably requires disclosure of exactly this situation – even if no government regulation does.

And even if your agreement somehow doesn’t require disclosure, your prime broker is going to find out. The SEC might contact them directly for records. Word travels in the industry. Your Form ADV disclosure will become public. The question isn’t whether to tell your prime broker about the subpoena. The question is whether they hear it from you first or learn about it some other way – and which scenario ends better for you.

The Contractual Obligation Most Managers Miss

Lets talk about what your prime brokerage agreement actualy says, becuase this is were most fund managers get surprised.

Prime brokerage agreements are written by the prime broker’s lawyers to protect the prime broker. Every provision is designed to give them maximum information and maximum flexibility. They want to know about anything that might affect there exposure to you.

Look at your representations and warranties section. Theres probly language saying you represent that you are not subject to any pending regulatory investigation or proceeding. When you signed the agreement, that representation was true. When the SEC subpoena arrives, that representation is no longer true. Depending on how your agreement is structured, you may have an obligation to update representations that become false.

Look at your notification covenants. Many agreements require you to notify the prime broker of “material changes” in your regulatory status or legal situation. An SEC subpoena is definately a material change. The agreement might specify notification within a certain timeframe – 24 hours, 48 hours, “promptly.”

Look at the termination provisions. Most agreements define “cause” for termination to include things like “regulatory proceedings involving the client” or “any investigation by a government agency.” If the agreement lets them terminate for cause when your under investigation, they definately want to know about the investigation.

The obligation to disclose comes from your contract, not from SEC regulations. But its still an obligation. Breaching it gives the prime broker grounds to terminate and potentially to claim you misrepresented your situation – which creates its own legal problems.

WARNING: Your prime brokerage agreement likely requires disclosure of SEC investigations through representations, covenants, or notification provisions. Failure to disclose may breach the agreement and give the prime broker termination rights “for cause.”

How Prime Brokers Actually Find Out

OK so lets say you decide not to tell your prime broker. You think: maybe the investigation will blow over, maybe nothing will come of it, maybe I can resolve this quietly. How long until they find out anyway?

Heres the reality. Prime brokers find out about investigations through multiple channels, and none of them require you to tell them.

Channel one: the SEC contacts them directly. Prime brokers hold your assets, execute your trades, maintain your records. The SEC might subpoena the prime broker for information about your trading activity, your positions, your account history. When that subpoena arrives, your prime broker knows your under investigation – and they know you didnt tell them.

Channel two: Form ADV. If your registered with the SEC, you have disclosure obligations on Form ADV. Depending on the stage of the investigation, you might need to disclose it. That disclosure is publicly searchable on the SEC’s Investment Adviser Public Disclosure database. Prime broker compliance departments regularly check IAPD for there clients. They will see the disclosure.

Channel three: industry gossip. The investment management business is small. People talk. The SEC examiner who visited your office mentioned it to someone. Your lawyer’s firm represents other funds and word spreads internally. A former employee is interviewing elsewhere and it comes up. Prime brokers hear things. There risk management teams are specificaly tasked with monitoring for exactly this kind of information.

Channel four: Form PF. If your a large hedge fund adviser, certain events trigger 72-hour reporting to the SEC on Form PF. If your prime broker terminates or materially restricts there relationship with you, thats a reportable event. So even if you somehow avoid telling the prime broker and they dont find out – if they DO find out and terminate, now you have 72 hours to report that termination to the SEC.

The information wants to come out. There are to many pathways for it to stay hidden. Your choice isnt whether the prime broker learns about the investigation. Your choice is how they learn and what that means for your relationship.

The Termination Cascade Nobody Explains

Heres what actualy happens when your prime broker learns your under SEC investigation, wheather you tell them or they find out another way.

Step 1: Risk management gets involved. The relationship manager you deal with day-to-day dosent make decisions about regulatory matters. This goes to the risk committee, the compliance department, senior management. People you’ve never met are now deciding your fate.

Step 2: They review the agreement. The lawyers pull your prime brokerage agreement and examine the termination provisions. They look for “cause” definitions. They look for material breach language. They assess there options.

Step 3: They restrict first, terminate later. Most prime brokers wont immediately terminate – that creates market disruption and potential liability. Instead, they restrict. They reduce your margin. They stop lending securities for shorts. They narrow the assets they’ll custody. They make it harder to operate.

Step 4: Formal termination notice. Eventually, they send the letter. 30 days notice if your lucky. Immediate termination “for cause” if they can justify it. You need to find a new prime broker while under SEC investigation – which is basicly impossible becuase no prime broker wants to onboard a fund under investigation.

Step 5: Position liquidation scramble. You have 30 days (or less) to move your positions somewhere. But you cant find a new prime broker. You have to liquidate. Forced selling at bad prices. Investors see the performance hit. Redemptions accelerate.

Step 6: Form PF report. If your a large hedge fund adviser, you have 72 hours to report the prime broker termination to the SEC on Form PF. Now the government officialy knows your prime broker relationship has collapsed.

This cascade happens wheather you disclosed proactivly or not. The only difference is how angry your prime broker is and wheather they terminate “for cause” or “without cause.” Disclosure might buy you more time and better terms on the way out. Non-disclosure guarentees the worst possible exit.

CRITICAL: Prime broker termination during SEC investigation triggers Form PF reporting within 72 hours for large hedge fund advisers. The government will know about the relationship collapse regardless of what you disclosed.

The Trust Problem That Dosent Heal

Heres something fund managers dont fully appreciate until there living it: the relationship with your prime broker is built on trust, and SEC investigation fundamentaly damages that trust.

Your prime broker extends you leverage. They lend you securities. They give you credit. They do this becuase they beleive you will manage there exposure responsibly and that your representations about your business are accurate.

When they learn your under SEC investigation – especialy if they learn it from someone other then you – that trust breaks. They question everything:

• If you didnt disclose this, what else didnt you disclose?
• If the SEC is investigating, what did you actualy do?
• Is there exposure in your book they dont know about?

The relationship might continue in some form, but its never the same. Every margin call gets scrutinized. Every position change raises questions. The generous terms you negotiated when you were a clean client become restrictive terms appropriate for a problem account.

And if they find out you actively hid the investigation from them? Trust is completly destroyed. Youve demonstrated that you will deceive them when its convienent. No prime broker wants to extend leverage to someone whos proven they will hide material information. Even if they dont immediately terminate, your relationship is effectivly over.

The Proactive Disclosure Calculation

So what happens if you tell your prime broker proactivly? Is that better?

Proactive disclosure has real costs. The moment you tell them, they know. They cant unknow it. The risk assessment process starts immediatly. You might lose the relationship even faster then if youd stayed quiet and hoped they wouldnt find out.

But proactive disclosure also has benefits that matter.

First, you control the narrative. You can explain the investigation, provide context, describe your response strategy. They hear your version first, not the gossip version, not the SEC’s version.

Second, you demonstrate good faith. Telling them voluntarily shows your not trying to hide things. That matters for how they treat you going forward. Voluntary disclosure might get you termination “without cause” with full notice period, rather then termination “for cause” with immediate effect.

Third, you preserve legal defenses. If the prime broker claims you breached the agreement through non-disclosure, and you actualy did disclose promptly, you have a defense. If you hid it and they find out, you have no defense and potentialy additional liability.

Fourth, you might negotiate transition time. A prime broker who learns proactivly might work with you on an orderly transition – 60 days instead of 30, help finding a new arrangement, graduated restriction rather then immediate cutoff. A prime broker who discovers you hid something is not inclined to be helpful.

The calculation isnt easy. Disclosure triggers the cascade faster but potentialy with better terms. Non-disclosure might buy time but guarentees worse outcome if discovered. Given the multiple channels through which prime brokers find out, the odds of successful concealment are low.

The Timing Question That Haunts Managers

Heres a question that dosent have a clean answer: when exactly do you tell them?

The SEC sends a document subpoena. Its early stage – they want records, not testimony yet. Maybe this is routine. Maybe nothing comes of it. Do you call your prime broker immediatly, potentially triggering the cascade for something that might blow over?

Or do you wait. You respond to the document request. You see what develops. If the SEC closes the inquiry with no further action, you never had to tell the prime broker and nothing changes. If it escalates to testimony, Wells notice, formal charges – then you disclose.

This wait-and-see approach has appeal but its dangerous. Every day you wait is another day your representations to the prime broker are potentially false. Every day is another day you could be accused of concealment. And if the prime broker finds out while your waiting, the optics are terrible – you knew, you had time to tell them, and you chose not to.

The safest answer legally is: tell them as soon as you have a disclosure obligation under the agreement. If your agreement requires notification of “regulatory proceedings” or “government investigations,” the subpoena probly triggers that obligation. Dont wait to see how it develops. The obligation exists from day one.

But “safest legally” and “best for the relationship” arent always the same thing. Some managers have successfully navigated early-stage inquiries without disclosure and had the matter close quietly. They took a risk and it worked. Others took the same risk and had it blow up spectacularly when the prime broker learned they’d been hiding something.

Theres no formula here. You need to read your agreement carefully, assess the stage and seriousness of the investigation, evaluate your prime broker relationship, and make a judgment call. Talk to your lawyer before deciding. But dont pretend waiting has no risks – the risks of waiting might exceed the risks of early disclosure.

What the Prime Broker Is Really Worried About

To understand how your prime broker will react, you need to understand what there actualy concerned about.

First, credit risk. They’ve extended you leverage, margin, credit facilities. If the SEC investigation results in sanctions, penalties, or business collapse, can you repay what you owe? Will there positions with you become losses?

Second, operational risk. You hold assets with them, trade through them, depend on there systems. If the investigation disrupts your operations, does that create problems for them? If you have to liquidate rapidaly, does that affect markets were there also active?

Third, regulatory risk. Prime brokers are regulated entities themselves. If there facilitating trading for a fund thats violating securities laws, they could face regulatory scrutiny. They dont want to be accused of enabling or ignoring client misconduct.

Fourth, reputational risk. Prime brokers compete for business based partly on the quality of there client base. Having clients under SEC investigation – especialy if those investigations become public – damages there reputation. They dont want to be known as the prime broker for problematic funds.

Fifth, litigation risk. If the SEC investigation involves fraud, investors might sue. If investors sue, they might try to reach deep pockets – including the prime broker. Even if those claims are ultimately dismissed, defending them is expensive and distracting.

Your prime broker isnt terminating you becuase they dislike you personally or becuase one subpoena proves wrongdoing. There terminating becuase the investigation creates risks across multiple dimensions that outweigh the benefits of keeping you as a client. Understanding this helps you craft a disclosure that addresses there real concerns.

The Multi-Prime Reality

Heres something that changes the calculation for sophisticated funds: prime broker diversification.

After Lehman collapsed in 2008, funds learned they couldnt put all there assets with one prime broker. Single points of failure are dangerous. Most institutional-quality funds now use multiple prime brokers – two, three, sometimes more.

This changes the disclosure dynamics. If you have three prime brokers and you disclose to all three, you might lose all three simultaniously. Thats catastrophic – complete inability to trade or hold positions.

But if you disclose and one terminates while two continue, you still have operational capability. You can move positions, you can still trade, you have time to find a replacement for the one that left.

The multi-prime structure also affects information flow. If you tell Prime Broker A and they terminate, Prime Brokers B and C will notice. They talk to each other. They share risk information through industry channels. The termination by A will raise questions at B and C even if you havent told them directly.

Theres no perfect answer here. But the multi-prime reality means disclosure decisions affect your entire operational infrastructure, not just one relationship. Think through the cascade across all your prime broker relationships before deciding how to handle disclosure.

What You Should Actually Do

Stop thinking about this as “do I have to tell them.” Think about it as “whats the best way to manage an inevitably bad situation.”

Pull your prime brokerage agreement immediatly. Find the representations and warranties section. Find the notification covenants. Find the termination provisions. Understand exactly what obligations you have and what rights the prime broker has.

Talk to your securities lawyer before you do anything. The disclosure obligation in your agreement might have specific timing requirements. There might be ways to frame the disclosure that preserve your options. Legal counsel can help you navigate.

If you decide to disclose, control the conversation. Request a call with your relationship manager and there compliance counterpart. Explain the situation, provide context, emphasize your cooperation with the SEC and your confidence in the outcome. Dont send a cold email that lands in risk managment without any context.

Prepare for restriction or termination regardless. Start identifying alternative prime brokers now – before you disclose, before you need them urgently. Having a backup plan makes termination survivable rather then catastrophic.

And understand the Form PF implications. If your a large hedge fund adviser and your prime broker terminates or materially restricts the relationship, you have 72 hours to report that to the SEC. The government is going to know regardless. Acting like you can hide the situation from everyone is denial, not strategy.

Your prime broker relationship is probly not going to survive the SEC investigation intact. The question is wheather it ends in a controlled, professional manner that preserves some options – or wheather it ends in chaos and recrimination that makes everything worse.

Choose the professional exit. Tell them yourself. Control the narrative before someone else controls it for you.