SEC Staffer Highlights Private Fund and Private Equity Broker-Dealer Issues

by Ropes & Gray LLP
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On April 5, 2013, David Blass, Chief Counsel of the SEC’s Division of Trading and Markets (which regulates broker-dealers), gave an important speech highlighting two “significant areas of concern” about broker-dealer registration which private fund sponsors should consider. The Securities Exchange Act of 1934 (the “1934 Act”) defines a broker as “any person engaged in the business of effecting transactions in securities for the account of others.” The SEC is currently conducting “presence exams” of newly registered investment advisers, including advisers to hedge funds and private equity funds. In connection with these exams, the SEC has noted the practice of private fund sponsors paying transaction-based compensation to personnel for selling fund interests or having personnel whose only or sole functions are to sell interests in the sponsor’s funds. Blass also described the practice of PE sponsors receiving transaction-based compensation for providing investment banking services relating to the sponsor’s portfolio companies. Blass urged private fund sponsors to consider these issues before SEC examiners arrive. Our experience to date with presence exams confirms that the SEC is focusing on these issues.

Sales of Interests in Private Funds -

Blass stated that activities such as marketing interests in a private fund or soliciting or negotiating transactions with respect to those interests might require private fund personnel to register as a broker-dealer, noting that “the importance of each of these activities is heightened where there also is compensation that depends on the outcome or size of the securities transaction.” This aspect of Blass’s remarks is potentially of interest to all private fund managers in connection with fundraising activities, including managers of private equity funds, hedge funds, real estate funds and private funds of funds. As reported in our Alert of March 13, 2013, the SEC recently announced the settlement of enforcement proceedings against a private equity firm, one of its partners and an unregistered finder, for the finder’s solicitation of more than $500 million in capital commitments for two private funds in violations of the broker-dealer registration provisions of the 1934 Act. Blass observed that these cases “demonstrate that there are serious consequences for acting as an unregistered broker, even where there are no allegations of fraud.” The fund sponsor paid a penalty of $375,000, the partner paid a penalty of $75,000 and agreed to a nine month suspension from acting in a supervisory capacity at an investment adviser or a broker-dealer, and the finder agreed to be barred from the securities industry. Additionally, Blass suggested that an investor may have the right to rescind its investment in a fund if the investment transaction was consummated using an unregistered broker-dealer.

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