Broker-Dealer Registration in the Private Equity Fund Adviser Context: How Helpful Are FINRA’s New Capital Acquisition Broker Rules?

January 05, 2017

The U.S. Securities and Exchange Commission (SEC) announced on June 1, 2016, that Blackstreet Capital Management, LLC, a private equity fund advisory firm (BCM), and its owner had agreed to pay more than US$3.1 million to settle charges that included, among other alleged violations, acting as an unregistered broker-dealer in violation of Section 15(a) of the Securities Exchange Act of 1934 (Exchange Act). See In the Matter of Blackstreet Capital Management, LLC and Murry N. Gunty, Release No. 34-77959 (June 1, 2016) (Blackstreet). 

The SEC alleged that BCM had acted as an unregistered broker through its receipt of transaction-based compensation in connection with the acquisition and disposition of portfolio companies for the two private equity funds that it advised. Specifically, the SEC alleged that, in return for transaction or brokerage fees, BCM performed brokerage activities in-house, including soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing, and executing securities transactions. The limited partnership agreements for the two funds expressly permitted BCM’s receipt of transaction or brokerage fees. Although the SEC noted that BCM received a management fee equal to two percent of aggregate capital commitments, which was reduced by a fraction of a percent each year following the expiration of the commitment period, there is no indication that the management fee was reduced or offset by the transaction-related fees. Accordingly, Blackstreet provides no insight as to the SEC’s current thinking regarding whether offsets of management fees against transaction-related fees are sufficient to eradicate “broker” status. (The general “message” of Blackstreet is further obscured because of the number of other alleged violations, and the published order reflects a negotiated settlement.) 

Shortly after the announcement of Blackstreet, on August 18, 2016, the SEC approved new Financial Industry Regulatory Authority (FINRA) rules governing the registration and regulation of “capital acquisition brokers” (CABs), which is not to suggest that the timing of the SEC’s approval of FINRA’s CAB rules was linked to Blackstreet. As a reminder, at issue in Blackstreet was whether the receipt of securities transaction-based fees and other badges of broker-dealer activity required registration with the SEC pursuant to Section 15(a) of the Exchange Act. The CAB rules, which become effective April 14, 2017, are not an exemption from broker-dealer registration. Instead, they are intended to reduce the regulatory burdens on CABs commensurate with the scope of their activities. On January 3, 2017, FINRA will begin accepting applications for FINRA membership as a CAB (whether by entities that are not registered as broker-dealers, but decide to seek CAB status, or by existing FINRA members who wish to elect CAB status). 

As set forth in CAB Rule 016(c)(1), a CAB is defined as a registered broker and FINRA member that engages only in one or more enumerated activities: 

  1. advising a private fund or other issuer about its securities offerings or other capital raising activities; 

  2. advising a company about its purchase or sale of a business or assets or possible restructuring, including through a merger, going-private transaction, or divestiture; 

  3. advising a company about the selection of an investment banker; 

  4. assisting in the preparation of an issuer’s offering materials; 

  5. providing fairness opinions, valuation services, expert testimony, litigation support, and negotiation and structuring services; 

  6. qualifying, identifying, soliciting, or acting as a placement agent or finder for the sale of unregistered securities to institutional investors in connection with a change of control of a privately-held company (i.e., only in connection with very limited secondary market transactions, and which would not include sales of securities received as compensation for placement agent services);1 and 

  7. effecting securities transactions in connection with the transfer of ownership and control of a privately-held company to a buyer that will actively operate the company or the business conducted with the assets of the company in accordance with SEC guidance that permits a person to engage in such activities without registration as a broker-dealer, particularly the M&A Brokers SEC No-Action Letter (Jan.13, 2014) [Revised Feb. 4, 2014]. 

Paragraph (c)(2) of CAB Rule 016 sets forth activities that CABs may not perform and generally none of these activities are ones in which firms that are solely investment advisers to private equity funds typically engage. Specifically, a CAB may not: (i) carry or introduce customer accounts; (ii) hold or handle customers’ funds or securities; (iii) act as principal or agent in accepting customers’ orders for the purchase or sale of securities, except as permitted when acting as a placement agent or finder or effecting transactions in connection with a change of control as generally described in 6 and 7 above; (iv) have investment discretion on behalf of any customer; (v) engage in proprietary trading of securities or market-making activities; (vi) participate in or maintain an online platform for offerings of unregistered securities pursuant to Regulation Crowdfunding or Regulation A under the Securities Act of 1933; or (vii) effect securities transactions that are subject to FINRA’s trade reporting rules. 

While Blackstreet is not necessarily additive to interpretations of whether broker-dealer registration is required, the SEC’s order has garnered substantial attention and prompted some review of the issue by individual advisers. Accordingly, a private equity firm that has determined to register as a broker-dealer and meets the definition of a CAB, may wish to consider some of the following when weighing whether to become a full FINRA member or a CAB: 

  1. Pursuant to CAB Rule 112, the FINRA new membership application (NMA) process for CABs will generally be the same as for full FINRA members, including the 180 days granted to FINRA under Rule 1013 to process an NMA. For CAB applicants filing on January 3, 2017, however, FINRA has generally undertaken to complete the process by the April 14, 2017 effective date of the CAB rules. 

  2. Pursuant to CAB Rule 201, CABs will be subject to FINRA’s Rule 2010 (Standards of Commercial Honor and Principles of Trade), which gives FINRA broad authority over the conduct of CABs.

  3. CAB Rule 221 (Communications with the Public) is more streamlined than FINRA Rule 2211, which applies to full FINRA members and generally is limited to requiring that communications be fair and based on principles of fair dealing and good faith, and prohibiting false and misleading statements. 

  4. A CAB’s principals and associated persons will be subject to the same registration, qualifications, and continuing education requirements as principals and representatives of full FINRA members. 

  5. CABs will not be required to hold annual compliance meetings, review and investigate transactions, or conduct internal inspections of their businesses. 

  6. CAB supervisory personnel will not be not subject to FINRA’s restrictions on supervising their own activities, or reporting to, or having their compensation or continued employment determined by, a person that they are supervising. 

  7. A CAB’s chief executive officer will not be required to certify that the CAB’s compliance policies and written supervisory procedures are reasonably designed to achieve compliance with applicable laws, rules, and regulations. 

  8. CABs will not be not subject to FINRA’s rules related to fair prices and commissions (FINRA Rule 2121), charges for services (FINRA Rule 2122), and net transactions (FINRA Rule 2124) even when the CAB acts as a placement agent or finder or effects securities transactions in connection with the transfer of ownership and control of a privately-held company. As noted above, however, CABs will be subject to FINRA’s standards of commercial honor and just and equitable principles of trade, which could be used to sanction clearly unreasonable commissions or fees. 

  9. Associated persons of CABs will not be permitted to engage in private securities transactions (i.e., securities transaction outside the regular course or scope of such person’s employment at the CAB). Subject to certain conditions, associated persons of full FINRA members may engage in private securities transactions pursuant to FINRA Rule 3280. 

  10. Pursuant to CAB Rule 331, CABs will be required to conduct independent testing for compliance with anti-money laundering requirements every two years, rather than every year as required of full FINRA members. 

  11. The “know your customer” and suitability requirements for CABs under CAB Rules 209 and 211, respectively, are generally similar to the corollary rules applicable to full FINRA members, i.e., FINRA Rules 2090 and 2111, respectively, as interpreted for institutional customers that are represented by agents. In each case, compliance will be facts and circumstances-dependent. 

  12. CABs will be required to maintain less information about customers under CAB Rule 451 than is required of full FINRA members under FINRA Rule 4512. 

  13. CABs will not be required to maintain business continuity plans pursuant to FINRA Rule 4370, although if the CAB is also a registered investment adviser, it may be required to do so under proposed SEC requirements. See Release No. IA-4439 (June 28, 2016). 

  14. The CAB rules do not include analogs to FINRA rules that are irrelevant to the activities in which CABs will be permitted to engage (e.g., rules related to trading data and trade reporting). Of course, a full FINRA member that does not engage in trading activities is not subject to those rules, either. 

  15. A CAB will not be permitted to chaperone a foreign broker pursuant to Rule 15a-6 under the Exchange Act even if the foreign broker’s activities are limited to those permitted under Rule 016(c). 

  16. If a CAB determines to engage in activities outside the scope of CAB Rule 016(c)(1) or that are enumerated in CAB Rule 016(c)(2), CAB Rule 116 will require the CAB to apply to FINRA for approval pursuant to NASD Rule 1017. Under Rule 1017, FINRA has up to 180 days from the time that the Continuing Membership Application (CMA) is filed to approve the request. Pursuant to Rule 1017(a)(5), only activities that constitute a material change in business operations of a full FINRA member (e.g., an increase in its minimum net capital requirement pursuant to Rule 15c3-1 under the Exchange Act) require a CMA. 

  17. CAB Rule 240 provides that if a CAB or its associated person(s) engage in broker-dealer activities that are inconsistent with CAB Rule 016(c) FINRA has the right to examine for and enforce all FINRA rules—not just CAB rules–against the CAB and its associated persons. 

Circling back to whether the CAB rules are helpful, and with the above points in mind, the answer is probably “yes” for private equity fund advisers that are able to limit their activities to those permitted of CABs. The compliance costs will be at least incrementally lower and we would expect FINRA to develop examination modules that are tailored to CABs and the CAB rules. Presumably, there will not be the same challenges of educating regulators about the scope of activities, which full FINRA members can face even if they do limit their activities. Firms that anticipate expanding their activities down the road, but have a pressing business—or compliance—need to be registered as a broker-dealer may also find it beneficial to register at the first of the year as a CAB and then file a CMA to obtain approval for expanded business activities. CAB-status is likely not the right path, however, for private equity firms that have short term plans to engage in activities beyond those permitted of CABs, or believe that they have risk of slipping into non-CAB activities. 

Private equity fund sponsors who would like to discuss whether becoming a CAB is the right course for your firm, should feel free to contact the author or your regular contact at Dechert. 


1) For purposes of the CAB rules, “institutional investor” is defined in Rule 016(i) to include:

1. any bank, savings and loan association, insurance company or registered investment company;
2. any governmental entity or subdivision thereof;
3. certain eligible employee benefit plans and qualified plans; , or multiple employee benefit plans offered to employees of the same employer; 
4. any other person, including a natural person, corporation, partnership, trust, or family office, with at least US$50 million in total assets;
5. any “qualified purchaser” as defined in section 2(a)(51) of the Investment Company Act of 1940; and 
6. any person acting solely on behalf of an institutional investor.

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