Private Equity Newsletter - Autumn 2013 Edition: Recent Statements by SEC Staff Generate Controversy over Whether Advisers to Private Equity Funds Must Register as Broker-Dealers


On April 5, 2013, David W. Blass, Chief Counsel of the Securities and Exchange Commission’s (“SEC”) Division of Trading and Markets, warned an American Bar Association (“ABA”) committee that private equity funds should consider whether the adviser and its internal sales staff might be subject to broker-dealer registration requirements.1 In his remarks to the ABA, Mr. Blass (whose comments may not reflect the views of the Commission itself) indicated that the SEC Staff would be “putting an increased examination focus on private fund advisers” and suggested that private fund advisers “may not be fully aware of all of the activities that could be viewed as soliciting securities transactions, or the implications of compensation methods that are transaction-based.” Mr. Blass stated that, given the “significant consequences of acting as an unregistered broker-dealer and the increased attention being given to this issue by the SEC staff, private fund advisers should consider reviewing their practices to determine whether any activities that may be approaching or crossing the line would require broker-dealer registration.”  

Mr. Blass noted in his speech that “absent an available exemption or other [no-action or exemptive] relief, a person engaged in the business of effecting transactions in securities for the account of others must generally register under Section 15(a) of the Securities Exchange Act of 1934 (“Exchange Act”) as a broker.” Some of the activities or factors he suggested that might trigger the broker-dealer registration requirement include:

  1. marketing securities such as private fund interests,
  2. soliciting or negotiating securities transactions, or
  3. handling customer funds or securities. 

Mr. Blass emphasized that a hallmark of broker activity is receipt of transaction-based compensation (a “salesman’s stake”) in connection with a securities transaction.

The Controversy – Investment Banking

Mr. Blass described three types of broker-dealer registration issues the Staff has observed in connection with newly registered private fund advisers, including private equity funds. One involves the adviser’s employees receipt of transaction-based compensation for sales of interests in a fund. Another pertains to employees of the adviser whose primary function is to sell interests in advised funds, whether or not such employees receive transaction-based compensation.

The third, and perhaps most controversial, issue identified by Mr. Blass involves the receipt by the adviser, its employees or affiliates, of transaction-based compensation – often from portfolio companies – for services he labeled as “investment banking” activities. While he spoke directly to private equity managers, he also noted that the same analysis would apply to business development companies and other funds. In his speech, Mr. Blass noted that portfolio companies of private equity funds often pay investment banking-like fees to the fund manager or affiliates for arranging various types of financing or capital raising for the portfolio company, and that the fees appear to be transaction-based compensation that would trigger broker-dealer registration requirements. 

Mr. Blass went on to state that while many private equity fund advisers or managers charge transaction fees for portfolio company transaction assistance, 80-100% of such fees frequently are used to offset management fees that would be payable to the adviser. Although Mr. Blass did not indicate what regulatory interests, other than (in his view) transparency, would be served by requiring private equity managers to register as broker-dealers, he rejected the notion that the investment manager and the fund should be viewed as the same. He stated that it was “crystal clear” to him that if the manager retained any portion of the investment banking fee, the manager and the fund were distinct entities for purposes of his analysis. However, if transaction fees completely offset advisory fees charged by the private fund manager, “one might view the fee as another way to pay the advisory fee, which . . . would not appear to raise broker-dealer registration concerns.”

Suggestions by Mr. Blass Relating to Marketing

With respect to marketing, Mr. Blass suggested that “private fund advisers should consider reviewing their practices to determine whether any activities that may be approaching or crossing the line would require broker-dealer registration.” Some of the issues that Mr. Blass noted should be considered by private fund advisers in connection with this broker-dealer registration question include: whether the adviser has a dedicated sales force or marketing department; whether its employees who solicit investors have other responsibilities; and how employees are compensated.

He noted that the conditions of Exchange Act Rule 3a4-1, a non-exclusive safe-harbor from broker-dealer registration (the misnamed “issuer’s exemption,” which is really a conditional exemption for employees of an issuer) may be difficult for some private fund advisers to satisfy. The major conditions of the Rule require that employees:

  1. must limit their solicitation activities to certain specified financial institutions;
  2. must perform substantial other duties for the issuer not related to marketing, may not have been registered as a broker-dealer or associated person of a broker-dealer in the previous 12 months, and may not participate in an offering more often than once every 12 months; or
  3. may not engage in individualized oral interaction with investors. While Rule 3a4-1 does not permit payment of transaction-based compensation, many funds that do not engage in frequent offerings of securities are able to rely on the rule to raise assets.

However, as Mr. Blass notes, advisers who become more active in raising capital, the limitations on frequency of offerings and direct communications often preclude reliance on the safe harbor.

Some Hope?

Having raised a number of issues, without providing any concrete answers, Mr. Blass did offer some hope. Mr. Blass commented that the SEC Staff is interested in talking about these issues and suggested that more guidance may be forthcoming. Mr. Blass also stated that he was gathering information and seeking to interact with the industry on various issues. For example, he indicated interest in exploring exemptions tailored to private equity fund advisers, noting however, that transaction-based compensation would remain “problematic.” He stated that he had in mind, however, a potential exemption, like Rule 3a4-1, but tailored to private equity funds, among others.

Transaction-Based Compensation – Investment Banking Activity

Following his speech we understand that Mr. Blass and his colleagues have been willing to meet with representatives of the private equity fund industry to discuss compensation issues, and the role of the advisor in private equity funds. A team from Dechert was invited to meet with the SEC staff shortly after his speech to discuss the issues, and argued that, unlike traditional brokers, the adviser to a private equity fund has an identity of interest with the fund’s investors based on the economic arrangements of the fund that tie manager success to the success of the funds. The function of the investment manager to a private equity fund is a long-term advisory function, subject to a fiduciary standard, and the investment manager is acting on behalf of the fund as a principal – not simply as an agent. Notwithstanding the presence of transaction related compensation, ultimately the adviser in most current deals acts as an owner and does not have the same “salesman’s” stake in transactions which creates the conflict of interest requiring the protection of the laws and regulations designed for broker-dealers.    

In light of the institutional nature of the investors, the fact that managers are registered advisers, and lack of any “salesman’s stake,” it was unclear whether any policy interest of the SEC would be served by requiring fund managers to also register as broker-dealers in order to manage private equity funds. Based on this meeting, and comments from others, we believe that the SEC staff is now giving further consideration to whether or not the investment banking functions of private equity fund managers should require broker-dealer registration. While we believe that advisers should pay careful attention to Mr. Blass’ comments regarding marketing, it is unclear at this time what direction the SEC, or its Staff, will take with respect to “investment banking” functions. 


1 David W. Blass, Chief Counsel, Division of Trading and Markets, SEC, Address at the American Bar Association, Trading and Markets Subcommittee Meeting: A Few Observations in the Private Fund Space (Apr. 5, 2013). Mr. Blass is the SEC Staff member primarily responsible for interpreting the SEC’s broker-dealer registration requirements.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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