Is your firm a broker-dealer?

Who would have thought all this time that some private equity firms have been acting as broker-dealers, and not investment managers, as they negotiate the terms of their transactions, including of IPOs, acquisitions and dispositions?

David Blass, head lawyer for the US Securities and Exchange Commission’s division of trading, apparently. Speaking before the American Bar Association earlier this month, Blass said GPs may fall within the definition of a broker when effecting securities transactions.   

His reasoning was that private fund personnel dedicated to selling fund interests, say a marketing team, are technically brokers, especially so when their compensation is tied to the outcome or size of the securities transaction. The same principle applies when negotiating a portfolio company’s IPO for instance, which may result in certain fees being paid to the fund adviser for their work in selling shares to the public. During his speech Blass went on to mention a number of types of deal fees that could be described as transaction-based compensation under the law, and urged GPs to consider these issues as SEC staff continue to inspect newly registered private equity firms.   

From a pure intellectual standpoint, there’s weight to his logic. But the real question is whether or not it

matters. Is there any compelling reason to have a head of investor relations for instance hold a Series 7 license? 

“It’s unclear to me, particularly in the transaction fee context, what public policy purpose would be served by concluding that certain types of fees should require broker-dealer registration for private equity firms, or any particular oversight on the issue for that matter,” says Dechert M&A partner Ken Young. 

Fortunately Blass appears aware that broker-dealer registration may be an unnecessary compliance burden for the industry. He is considering “a potential exemption like the issuer exemption, but one written specifically for private fund advisors” and wants to start dialogue on the topic. Moreover Blass acknowledged that broker-dealer registration concerns are eliminated when deal fees offset management fees, which many GPs allow for. 

For private equity compliance officers it may be frustrating to think of having to add another layer of complexity to their work, but encouraging to know that at least one SEC official is considering an exemption to broker-dealer registration. The SEC has already shown its willingness to issue heavy fines for GPs who fail to recognize broker-dealer rules, even where there are no allegations of fraud. Clarity on the matter should therefore be a top priority for the regulator in the coming weeks as firms continue to wrestle with SEC registration.