SEC Staff Raises Broker-Dealer Registration Issues for Private Fund Advisers

April 10, 2013

The Chief Counsel of the Securities and Exchange Commission’s (SEC) Division of Trading and Markets, David Blass, recently reminded private fund advisers that certain practices used to sell private fund interests may require broker-dealer registration.[1] In remarks addressed to the Trading and Markets Subcommittee of the American Bar Association on April 5, 2013, Blass identified activities that could require broker-dealer registration and emphasized the serious consequences for acting as an unregistered broker-dealer, such as a possible right of rescission to investors, even where no fraud is involved.

Practices Observed by SEC Staff May Implicate Broker-Dealer Registration

Blass identified two practices SEC staff has observed in connection with private fund advisers that warrant attention. In the first practice, a private fund adviser pays its personnel transaction-based compensation for selling interests in funds or has personnel whose sole or primary function is to sell interests in funds. Blass commented that payment structures based even in part on the number of investors that purchase interests in the fund or the amount of capital contributed by such investors, which may be linked to securities transactions, could trigger broker-dealer registration requirements. In addition, he stated that dedicated employees working within an adviser’s “marketing” department or whose primary function is to solicit investors may raise broker-dealer registration concerns. Blass stressed that private fund advisers should consider how they go about obtaining new investors in their funds and retaining existing ones.

In the second practice, a private fund adviser, its personnel, or an advisory affiliate receive transaction-based compensation for purported investment banking or other broker activities relating to one or more of the fund’s portfolio companies. For example, an adviser or its affiliate that serves as general partner of a fund may receive fees in connection with the acquisition or disposition (including initial public offering) of the portfolio company, or a recapitalization of the portfolio company. Such fees are described as compensation for “investment banking activity” that includes negotiating or structuring transactions, or identifying and soliciting purchasers or sellers of the portfolio company’s securities. Blass conveyed that the practice of collecting fees in these circumstances appears to involve transaction-based compensation that is linked to the adviser or general partner effecting securities transactions within the meaning of “broker.”

Blass articulated that, in his view, an adviser’s receipt of fees from portfolio companies may not raise broker-dealer registration concerns where the adviser reduces the investment management fee payable by the fund by the amount of fees collected from the portfolio companies. This is because the portfolio company fees would then appear to be an alternative form of payment of the investment management fees. However, Blass refuted any potential rationalization that a private fund and its general partner should be viewed as the same person such that no transactions are effected “for the account of others” within the definition of broker. Blass remarked that payment of fees to the general partner rather than to the fund itself makes it clear that, for purposes of broker-dealer status, the fund and its general partner are distinct entities with distinct interests.

Availability of Exemptions or Other Relief Is Limited

The issuer safe harbor in Rule 3a4-1 under the Securities Exchange Act - commonly called the “issuer exemption” - provides a non-exclusive safe harbor under which associated persons of certain issuers can participate in the sale of an issuer’s securities in certain limited circumstances without being considered a broker. However, to rely on the safe harbor a person must satisfy three pre-conditions as well as one of three additional conditions,[2] which Blass believes makes it difficult for private fund advisers to fit within the safe harbor.

Consequences of Acting as An Unregistered Broker-Dealer May Be Serious

Blass reiterated the significant consequences of acting as an unregistered broker-dealer, emphasizing a recent enforcement action[3] in which the SEC settled charges against a fund adviser and its principal for paying an independent consultant to solicit investors in the fund when the adviser knew or should have known that the consultant was not registered as a broker-dealer. He further cautioned advisers that hiring an unregistered broker-dealer may provide a right of rescission to any investors whose transactions are intermediated by the broker-dealer. Because of such consequences and the increased attention being given to this issue by the SEC staff, private fund advisers should review their practices, and consult counsel as necessary, to identify any activities that may approach or cross the line and potentially require broker-dealer registration.

Advisers Asked To Weigh In On Potential Benefit of New Exemption for Private Fund Advisers

Blass encouraged private fund advisers to provide feedback on whether a new broker-dealer registration exemption specifically for private fund adviser is needed or would be helpful. O’Melveny & Myers is available to provide assistance if you would like to give feedback to the SEC regarding the unique circumstances private fund advisers face in marketing interests in the private funds they sponsor, or to provide guidance on broker-dealer registration status. For questions or additional information, please contact Heather Traeger at (202) 383-5232, Kris Easter at (202) 383-5364, or Matthew Cohen at (202) 383-5179.

[1] The full speech, A Few Observations in the Private Fund Space, is available at http://www.sec.gov/news/speech/2013/spch040513dwg.htm.  
[2] To rely on the safe harbor from broker-dealer registration, a person must satisfy, in addition to three pre-conditions, one of the following three conditions: (i) person limits the offering and selling of the issuer’s securities only to broker-dealers and other financial institutions; (ii) the person performs substantial duties for the issuer other than in connection with transactions in securities, was not a broker-dealer within the preceding 12 months, and does not participate in selling an offering of securities for any issuer more than once every 12 months; or (iii) the person limits activities to delivering written communication by means that do not involve oral solicitation by the associated person of a potential purchaser.
[3] See OMM’s client alert entitled “SEC Brings Enforcement Actions Against Private Fund Advisers” for more information about this and other recent enforcement actions against private fund advisers.


This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Heather Traeger, an O'Melveny partner licensed to practice law in the District of Columbia and Texas, Kris Easter, an O'Melveny counsel licensed to practice law in Texas, and Matthew Cohen, an O'Melveny associate licensed to practice law in the District of Columbia and California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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