Regulatory Focus and Developments on Potential Broker-Dealer Requirements for Private Fund Sponsor Activities

Published on: Oct 17th, 2016

Over the past few years we have seen increased focus on regulatory developments related to potential broker-dealer registration requirements that may be applicable to the sponsors of private funds.   Notwithstanding that there remains uncertainty around these developments, we thought it would be helpful to review these developments.

Private Fund Advisers’ Routine Practice of Taking Transaction Fees When Its Associated Persons Act Outside of the “Issuer Exemption”.  The issue of unregistered broker-dealer activity being conducted by private fund advisers was raised in April 2013 when it was highlighted in a speech given by David Blass, then Chief Counsel of the SEC Division of Trading and Markets in which he noted that private fund advisers’ routine practice of taking transaction fees appeared to “fall within the meaning of the term “broker.”  This could also apply where an adviser “pays its personnel transaction-based compensation for selling interests in a fund” or has personnel “whose only or primary functions” are selling fund interests, and where the adviser, its affiliates or its personnel “receive transaction-based compensation for purported investment banking or other broker activities” relating to fund portfolio companies.

Blackstreet Enforcement Action.  In the June 1, 2016 press release related to the Blackstreet Enforcement action,  Andrew J. Ceresney, Director of the SEC Enforcement Division stated “[t]he rules are clear: before a firm provides brokerage services and receives compensation in return, it must be properly registered within the regulatory framework that protects investors and informs our markets.”

Limited Membership for broker-dealers.  The SEC recently approved a Financial Industry Regulatory Authority (“FINRA”) proposal to establish a new limited membership category for broker-dealers engaged solely in certain corporate financing advisory and capital raising activities, including the provision of such services on behalf of a private fund issuers, referred to as “capital acquisition brokers” (“CAB”).  The new rules, as detailed in the FINRA Regulatory Notice 16-37 issued on October 17, 2016 and effective on April 14, 2017 allow firms that engage only in these limited activities to be regulated as CABs, and be subjected to a simplified set of FINRA rules.

Takeaway.  Although there are likely future issues to arise in this area, the one thing that is sure is that Fund sponsors should continually review their sales infrastructure (related to roles and compensation) and all sources of transaction-based fees to determine whether such activities involve those specifically identified by the SEC as causing a violation of Section 15(a)(1) of the Securities and Exchange Act of 1934, as amended, for acting as an unregistered broker.  If applicable exemptions are not available (such as SEC Rule 3a4-1 (the “issuer exemption”) to Section 15(a)(1) of the Exchange Act) to the sponsor’s employees and/or associated persons and such fees and/or compensation arrangements are a core part of the sponsor’s business, they should consider various options which include, depending upon the particular facts and circumstances, partnering with an existing broker-dealer, or to form a captive broker-dealer. 

As always, Cordium is available to work with private fund sponsors on solutions for any noted issues.  This can involve working with a sponsor on reviewing applicable registration exemptions, assisting with the registration process for a CAB or traditional broker-dealer, or providing sponsors with an alternative broker-dealer registration and compliance program.

For Cordium’s Regulatory Update disclaimer, click here.

If you would like to know more about how Cordium can assist your firm or to discuss any matters contained within this briefing, please contact us or your regular Cordium consultant.

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