The Securities and Exchange Commission (SEC)’s recent enforcement action against Blackstreet Capital Management for performing brokerage services for portfolio companies and and receiving brokerage fees is a serious development for the industry, Jason Brown, private investment funds partner at Ropes & Gray told pfm.
In Blackstreet’s case, which saw the firm pay $3.1 million to settle the proceedings, the firm was penalized for performing brokerage services, instead of using investment banks or registered broker-dealers to provide such services. The SEC noted in its action that the services provided by Blackstreet included “soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing and executing the transactions”.
The SEC defines a broker-dealer as person or entity engaged in the business of effecting securities transactions for the account of others and expects all broker-dealers to register. In 2013 the practise of private equity firms charging transaction fees for executing deals was a major focus for the SEC.
At the time David Blass, chief counsel of the SEC’s Division of Trading and Markets indicated that the SEC Staff would be “putting an increased examination focus on private fund advisers” and suggested that they “may not be fully aware of all of the activities that could be viewed as soliciting securities transactions, or the implications of compensation methods that are transaction-based.” However, he also said that if the advisory fee is wholly reduced or offset by the amount of the transaction fee then it would “not appear to raise broker-dealer registration concerns.”
However, since then there had been various signals from the SEC staff that this was no longer a high priority, according to Brown.
It is unclear from the Blackstreet enforcement whether the advisory fee was entirely offset by the transaction fees and whether this would have made a difference to the case, said Brown.
In a policy paper last year the American Investment Council (formerly PEGCC) said that “layering broker-dealer regulations on private equity would levy unnecessary and significant costs on private equity firms.” The organization argued that private equity fund sponsors provide investment advisory services and expertise to their affiliated funds and portfolio companies and because they are not hired to be brokers, they do not meet the SEC definition of a broker.
The regulator’s increased focus on fees and expenses was highlighted in a speech by Andrew Ceresney, director of the SEC’s Division of Enforcement last month. Ceresney broke down the enforcement actions into three categories: advisers that receive undisclosed fees and expenses; advisers that misallocate expenses or shift them without permission; and advisers that fail to adequately disclose conflicts of interests, including conflicts arising from fee and expense issues.
More recently, during the SuperReturn conference in June, Robert Baker, assistant regional director of the SEC Division of Enforcement’s Asset Management Unit described the action against Blackstreet as being “the first case of a private-equity adviser violating section 15(a) of the [Securities Exchange Act of 1934] for acting as a broker and failing to register as a broker.” Baker cautioned that any “private-equity advisor that doesn’t have a broker-dealer registration and is earning transaction fees—I’m not saying that’s a violation—but it creates a question,” The Wall Street Journal reported.
If David Blass’s comments are still the SEC’s view then firms with less than 100 percent offset of management fees are at higher levels of risk, said Brown. However, those with full offset have a stronger argument.
According to Brown, although it is still early days, private equity firms have the following options; they can continue to charge transaction fees and risk being investigated by the SEC; register as a broker-dealer; stop taking transaction fees; or take transactions fees where there is no securities involved, such as selling a portfolio company as an asset which does not involve securities.