The dangers of in-house IR

If the SEC’s ban on placement agents is enacted, small and mid-sized private equity funds may need to bring IR staff in-house. But they’ll also need to avoid triggers that would force their firm to register as a broker-dealer.

Fifty percent of private equity firms raised their last fund with the help of a placement agent, according a PEI Research survey conducted this July. If the US Securities and Exchange Commission bars placement agents from interacting with pension funds, how will that 50 percent successfully raise their next vehicle?
Many of these teams are very lean, and don’t have the resources to hire a full-time investor relations professional. Two alternative options are being bandied about, according to market sources. The first is the possibility of hiring an in-house investor relations pro on a temporary basis during fundraising. Because the professional would be in-house, the private equity firm could avoid running up against the SEC ban, but wouldn’t have to commit the resources to bring someone on for the long-term.  
Where would this pool of talent come from? Many of them could be former placement agents, says Seth Goldblum, a managing director at private equity executive recruiting firm CMF Associates. If the ban goes through, that industry is bound to go through a contraction that leaves some professionals displaced and looking for work.
“At some point the placement agents are going to have to do other things,” Goldblum says. “I could see these folks basically becoming employees, where they essentially go in-house but they recognise that their employment is going be of a short-term variety. It’s like a consulting arrangement, except they’re employees.”
But firms who want to go down this path need to make sure that they don’t run afoul of broker-dealer rules. Under US securities laws, anyone who sells securities to investors must be registered as a broker-dealer. There is an exception for those who are only selling their own securities – including management companies selling securities for their affiliated funds. However there are a number of triggers that could cause the SEC to question whether a private equity IR professional is truly entitled to that exemption, says Charles Lerner, principal of Fiduciary Compliance Associates, a compliance consulting firm. 
“One of the factors that the SEC would use to determine if the [IR] person should be registered as a broker-dealer is to see whether they were recently registered as a broker-dealer,” he says. “They look at how the person is compensated – if they’re compensated by commissions (that is based on the amount of sales) for selling, then that looks like they’re more like a broker-dealer. They will also look at the person’s other responsibilities at the entity – if it’s solely selling securities, then it looks like they should be registered as a broker-dealer.” 
One way around this is to reward the temporary fundraiser with a bonus tied to broader performance metrics, rather than a straight commission based how much capital is raised. But it could prove difficult to incentivise people this way.
“Presumably you could give them a straight salary, so that it is not based upon how much they sell,” Lerner says. “But the reality is somebody is going to want to be compensated if they raise a lot of money. If you hire two people, and one of them raises 90 percent of the money, they will want to be compensated based on how much they sell.”
Another option is to simply retain some of the outsourced services of a placement agent – everything but the actual placement. Beleaguered placement agent Wetherly Capital is said to be planning to offer assistance with every step of the fundraising process except for the actual introductions. 
“I think you could see some of the smaller funds look to outsource everything but the contact part of the placement service – whether it be helping them to focus how they go after the money, their ‘pitch’ so to speak, or even to help identify the right investors, but stop short of actually making the contact and allow someone internally within the fund to do that,” Goldblum says. “Obviously, the contact is the most valuable piece. But maybe you’re not paying for access but you’re paying a slightly larger consultative fee, just not on the basis of actually closing the deal, and you stop short of actually having the ‘placement agent’ make contact, but there’s some sort of relationship there, or ‘warm referral’ so to speak.”