Answers coming on broker-dealer registration?

2014 may finally bring clarity to the private equity broker-dealer registration issue, write DLA Piper attorneys Nicolas Morgan and Benjamin Welsh Turner 

According to recent reports, the SEC may finally provide clarity on the subject of whether private equity fund managers must register as securities broker-dealers when they receive transaction-based compensation. It’s been reported that the SEC is considering a registration exemption to allow private equity funds to continue collecting certain transaction based compensation. If true, such an exemption would bring to a close speculation and uncertainty created over the last year by a series of SEC enforcement actions, no-action letters, and speeches by SEC officials around the issue of the Securities Exchange Act’s registration requirement for “any person engaged in the business of effecting transactions in securities for the account of others.”

The issue came to the fore in March of last year, when the SEC commenced an enforcement action against private equity firm Ranieri Partners, a former senior executive of the firm, and an unregistered “finder” who solicited over $500 million in capital commitments.


Less than a month after the Ranieri action, David Blass, chief counsel of the SEC’s Division of Trading and Markets, expressed concerns with whether the capital raising activities of private fund managers complied with broker-dealer registration requirements in circumstances involving the use of transaction-based compensation for fund personnel raising capital or fund personnel whose sole function was to raise capital; and compensation from portfolio companies by advisers or managers of private equity funds for “investment banking” or other transaction-related activities. Blass noted that with respect to the latter issue, though fees triggered off liquidity events are common among private equity firms, such compensation could trigger registration requirements.

However, the thrust of Blass’s comments may have been undercut by a March 22, 2013 no-action letter to FundersClub, an online venture capital adviser that posts information about start-up companies on a section of its website accessible only to FundersClub members who have been prequalified as accredited investors. FundersClub members submit non-binding indications of interest in an investment fund via the website and, when interest in a fund reaches sufficient level to fund the target amount agreed upon between FundersClub and a startup, FundersClub closes the indication of interest process. FundersClub then reconfirms investors’ interest and accredited status, and negotiates final terms between the investment fund and start-up.

In its no-action letter, the SEC indicated that FundersClub did not need to register as a broker despite the fact that its compensation scheme was tied to a liquidity event: FundersClub charged, upon an investment fund’s liquidation, carried interest (in most cases 20 percent or less) of any profits. 

Creating further uncertainty, in September of last year, Blass clarified his comments earlier in the year, emphasizing that his prior comments should not be interpreted as a declaration of new rules or a new investigative focus by the commission to “catch” private fund managers. Rather, according to Blass, his comments were intended kick-start open discussions with the private fund industry regarding broker-dealer registration issues and to make clear to fund managers that this was an “area of interest” for the commission.

Most recently, on January 31, 2014, commission staff issued a no-action letter with respect to “M&A brokers” – essentially advisors brokering the sale and purchase of businesses, indicating that M&A brokers may now advise on the purchase and sale of private companies without registering, even when the brokers receive transaction-based compensation.

If recent reports are accurate, the SEC staff may be readying a no-action letter that will clarify whether private equity fund managers may accept transaction based fees without registering as securities brokers, as the staff has done in FundersClub and for M&A brokers. Such a no-action letter would bring much needed clarity and consistency.

Nicolas Morgan Nicolas is the West Coast chair of DLA Piper’s securities enforcement practice. Benjamin Welsh Turner is a trial and appellate litigator. Both are based in Los Angeles.