SEC Charges Private Equity Adviser for Unregistered Brokerage Activity

June 14, 2016

The U.S. Securities and Exchange Commission (SEC) on June 1, 2016 announced a settled enforcement action against a private equity fund manager (Adviser) for acting as a broker-dealer without registering.1 The case is significant because it calls into doubt certain compensation practices that became nearly universal among private equity firms following SEC staff guidance.2 

According to the SEC, the Adviser received at least $1,877,000 in transaction-based compensation for providing brokerage services to the funds it managed and to the portfolio companies owned by the funds.3 

Without admitting or denying the findings, the Adviser agreed to be censured, and one of its principals (Principal) agreed to cease and desist from further violations and, jointly and severally, to pay disgorgement of over $2.3 million, including over $500,000 to be distributed to affected clients. The Adviser also agreed to pay approximately $280,000 in interest and a $500,000 penalty. 

SEC Focus on Unregistered Broker-Dealers and Implications for Private Equity Firms 

Under the Securities Exchange Act of 1934 (Exchange Act), any person who engages in the business of acting as a broker or a dealer is required to register as a broker-dealer or as an associated person of a broker-dealer.4 For decades, the SEC has provided guidance in no-action letters as to when a person is considered to be “engaged in the [securities] business.”5 Guidance also can be found in SEC enforcement actions against market participants that the SEC has determined were acting as broker-dealers without benefit of registration.6 

Private equity managers have historically charged both management fees (which are an expense of the funds) and transaction-related fees (which are charged to portfolio companies). Managers and their counsel have been aware of the SEC staff’s concerns about receiving transaction-based fees when the manager is not registered as a broker-dealer. Offsetting transaction fees against private equity fund management fees has been seen as a method for passing the benefit of the fees to the relevant fund’s limited partners, and most private equity managers have increased such offsets in recent years. 

In 2013, the then-Chief Counsel of the SEC’s Division of Trading and Markets, in a widely noted speech to the American Bar Association’s Trading and Markets Subcommittee, said that “absent an available exemption or other 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 Exchange Act as a broker.”7 Much of the rest of the then-Chief Counsel’s remarks focused on the SEC staff’s long-standing view that engaging in certain activities and receiving transaction-based or success-based fees for such activities would trigger the registration requirements of the Exchange Act – all well-known and uncontroversial positions. The former Trading and Markets' Chief Counsel also noted certain practices that private equity managers had adopted that appeared to ameliorate the broker-dealer registration concerns, stating that “to the extent the advisory fee is wholly reduced or offset by the amount of the transaction fee, one might view the fee as another way to pay the advisory fee, which, in my view, in itself would not appear to raise broker-dealer registration concerns.” This remark was the genesis of the widely held view – called into question at the beginning of June – that a 100% offset of portfolio transaction fees would not trigger broker-dealer registration for a private equity manager. Offsets of less than 100%, widely used in funds offered prior to the 2013 speech, have been disappearing from more recently formed funds, accelerating a trend that was already promoted by investor demand. Since 2013, and particularly in light of changes in senior staff of the SEC’s Division of Trading and Markets, many in the private equity community hoped for and have sought additional formal or informal guidance that would solidify this view of the relationship between private equity transaction fees and the broker-dealer registration requirements. 

Although the SEC staff has not issued private equity-specific guidance, on January 31, 2014, the staff issued a no-action letter providing guidance on avoiding broker-dealer registration for a distinct category of brokers engaged in securities transactions of privately-held companies (M&A Brokers).8 While a move in the right direction for the private equity community, many of the conditions to qualify as an M&A Broker conflict with the roles typically performed by private equity sponsors during the purchase or sale of private portfolio companies, including restrictions on control and custody of the related securities and involvement in financing arrangements.9 Nevertheless, the then-Chief Counsel’s remarks and the M&A Broker no-action letter fostered a growing acceptance of certain activity by persons who were not registered as broker-dealers, even though the activities had been at other times characterized by the SEC staff as badges of broker-dealer status. This latest SEC action threatens to undo that evolution. 

Without mentioning whether the Adviser’s funds benefitted from offsets, the specific facts of the transaction fees earned by the Adviser, or whether the Adviser qualified as an M&A Broker, the SEC determined that the Adviser and its Principal were engaged in brokerage services “with respect to the acquisition and disposition of portfolio companies, some of which involved the purchase or sale of securities, […] including soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing, and executing the transactions.” As the SEC’s Order indicated, disclosure was not the issue, as the fund documents permitted the Adviser to charge transaction or brokerage fees.10 Rather, the SEC charged that the Adviser and its Principal were not properly registered, or otherwise exempt from registration, as a broker-dealer. The SEC did not discuss the issue of offsets in its Order, which raises concerns about whether the use of offsets avoids broker-dealer registration requirements. This confusion is exacerbated because the Order was issued by the SEC, while the prior guidance came from the SEC staff. 

Additional Violations 

The SEC also faulted the Adviser for a number of additional issues. First, the Adviser was found to have failed to disclose, until after investors had committed capital, the payment of (and conflicts associated with) certain operating partner oversight fees paid by fund portfolio companies to the Adviser, where the Adviser’s personnel provided the portfolio companies certain “senior-level operating and management services to these companies in circumstances where the companies were having difficulty recruiting suitable talent to work directly for them.” The SEC also noted that these fees were not addressed in at least one of the fund’s gfoverning documents. 

Second, the SEC stated that the Adviser charged its funds for certain political and charitable contributions and entertainment expenses, including a luxury suite in Washington DC’s Verizon Center, even though such charges were not disclosed “until after the LPs committed capital and until after the contributions were made and the expenses occurred.” 

Third, the SEC indicated that the Adviser engaged in an improper conflicted transaction when it purchased shares of its fund’s portfolio companies without proper disclosure to investors and in violation of a priority repurchase right held by such portfolio companies. 

Fourth, the SEC indicated that the Principal violated the terms of a fund’s partnership agreement by purchasing interests of defaulting investors for his personal benefit rather than the fund, and by causing the fund to waive capital call obligations with respect to such interests (and additional interests he purchased) without proper disclosure to investors. 

And fifth, the Adviser was charged with a failure to adopt and implement written policies and procedures reasonably designed to prevent violations of the Investment Advisers Act of 1940, as amended, and its rules, including those list above. 

Recent and Related Developments 

On December 4, 2015, Financial Industry Regulatory Authority (FINRA) filed with the SEC a proposed rule change to create a new streamlined rule set (Proposed CAB Rules) that would apply to “Capital Acquisition Brokers” (CABs) and reduce their regulatory burden and compliance cost. This proposal may ease some of the burdens on private equity managers that do register as broker-dealers. 

Unlike the M&A Broker no-action letter, CABs will have to register as broker-dealers and become FINRA members. Nevertheless, FINRA’s Proposed CAB Rules provide less onerous FINRA compliance obligations if the registered broker-dealer limits its activities to corporate financing services, such as advising companies on mergers and acquisitions, raising debt or equity capital in private placements with institutional investors, or helping companies analyze their strategic and financial alternatives. In many cases, these firms register as broker-dealers only because they receive transaction-based compensation. CABs would not be allowed to handle customer funds or securities, accept orders to purchase or sell securities, exercise investment discretion on behalf of customers, or engage in market making or proprietary trading. As of June 14, 2016, SEC approval of the Proposed CAB Rules is still pending. 

Practical Effect of Order Remains Uncertain 

The issue of unregistered brokerage activities by private equity fund advisers has been raised in the context of examinations and other inquiries to unregistered entities. In many cases, private equity fund advisers have been able to respond to the SEC staff’s questions without enforcement action being taken. In light of this latest action, it remains to be seen whether there has been a shift in the SEC’s or its staff’s position, which could lead to wholesale revamping of private equity fund fee structures or result in the registration of fund advisers as broker-dealers. Private equity fund advisers may wish to review their fee structures and other activities in light of the SEC’s recent action. 


1) In the Matter of Blackstreet Capital Management, LLC and Murry N. Gunty, Rel. Nos. 34-77959 and IA-4411 (June 1, 2016). See also SEC: Private Equity Fund Adviser Acted As Unregistered Broker.
2) Lim, Dawn and Cumming, Chris, SEC Official Puts Broker-Dealer Issue Back on Private Equity’s Radar, The Wall Street Journal (June 7, 2016).
3) The SEC also found that the Adviser: (i) received undisclosed portfolio company oversight fees; (ii) used client assets for political/charitable contributions and entertainment expenses without authorization; (iii) purchased portfolio company interests without authorization; (iv) improperly purchased fund interests and exercised waivers for future funding obligations; and (v) failed to adopt and implement reasonably designed compliance policies and procedures. See Additional Violations, below.
4) See Section 15(a) of the Exchange Act.
5) See, e.g., Inland Realty Inv., Inc., SEC No-Action Letter (May 20, 1973), in which the SEC staff indicated that a person would be considered “engaged in the [securities] business” if the person receives transaction-based compensation in connection with securities transactions (the earning of a commission demonstrates success in effecting transactions for the account of others). See also MuniAuction, Inc., SEC No-Action Letter (Mar. 13, 2000), in which the SEC staff denied no-action relief from the broker-dealer registration requirements where the requestor conducted auctions of municipal bonds and other securities primarily on behalf of municipal bond issuers who wished to negotiate purchases and sales and used the MuniAuction website to communicate bids and accept offers. See also Davenport Management, Inc., SEC No-Action Letter (Apr. 13, 1993), in which the SEC refused to grant no-action relief to a corporation controlled by principals of a partnership that contracted with the corporation to, among other things, act as a “finder” for investors in, and investments for, the partnership, in exchange for transaction fees.
6) See Ram Capital Resources, LLC, Exchange Act Release No. 60149 (June 19, 2009), in which the SEC fined Ram Capital for selling PIPE investments without being registered as a broker-dealer and forced it to disgorge the fees it had earned. See also Ambit Capital Private Limited, Exchange Act Release No. 68295 (Nov. 27, 2012); Edelweiss Financial Services Limited, Exchange Act Release No. 68298 (Nov. 27, 2012); JM Financial Institutional Securities Private Limited, Exchange Act Release No. 68297 (Nov. 27, 2012); Motilal Oswal Securities Limited, Exchange Act Release No. 68296 (Nov. 27, 2012); and BANCO ESPIRITO SANTO S.A., Exchange Act Release No. 65608 (Oct. 24, 2011). In the foregoing actions, the SEC fined several Indian broker-dealers and a Portuguese bank for selling securities to U.S. investors without being registered. See also Ranieri Partners LLC and Donald W. Phillips, Exchange Act Release No. 69091 (Mar. 8, 2013). In Ranieri, the SEC fined Ranieri Partners, a principal of Ranieri and an independent contractor who was not registered, for selling investments in hedge funds it managed. State regulators in several states have recently shown more interest in pursuing unregistered broker-dealers for sales activities occurring in their states as well.
7) A Few Observations in the Private Fund Space, David W. Blass, Chief Counsel, Division of Trading and Markets, SEC, before the American Bar Association, Trading and Markets Subcommittee, Washington, D.C., April 5, 2013. As part of his remarks, Mr. Blass gave the standard SEC staff disclaimer that “my remarks represent my own views, and not those of the Commission, any individual Commissioner, or any other members of the staff.”
8) M&A Brokers, SEC No-Action Letter (January 31, 2014, as revised on February 4, 2014). Because only a limited number of states have adopted parallel exemptions, some market participants have concerns about the utility of the relief granted.
9) Id.
10) A takeaway from this decision is to ensure that documentation does not label or refer to services and compensation that would trigger the broker-dealer registration requirements, unless the facts otherwise require it.

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