Tue, 09/04/2013 - 14:37
By Jay Gould, partner, Pillsbury Winthrop Shaw Pittman LLP – In a speech before the American Bar Association’s Trading and Markets Subcommittee on 5 April, 2013, David Blass, the Chief Counsel of the Division of Markets and Trading, put hedge fund managers and private equity fund managers on notice that they may be engaged in unregistered (and therefore, unlawful) broker dealer activities as a result of the manner by which hedge fund managers compensate their personnel and, in the case of private equity fund managers, the receipt of investment banking fees with respect to their portfolio companies.
The good news is that Mr Blass indicated that the Staff of the Securities and Exchange Commission (the “SEC”) is willing to work with the industry to come up with an exemption from broker dealer registration for private fund managers that would allow some relief from the prohibitions against certain sales activities and compensations arrangements regarding the sales of private fund securities. This post will address only the sales compensation activities of hedge funds with an explanation of the private equity investment banking fee discussion to follow.
Mr Blass indicated that he believed that private fund advisers 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 that would give rise to the requirement to register as a broker dealer.
Mr Blass provided several examples that fund managers should consider to help determine whether a person is acting as a broker-dealer:
Mr Blass also addressed the use or misuse of Rule 3a4-1, the so-called “issuer exemption.” That exemption provides a nonexclusive safe harbor under which associated persons of certain issuers can participate in the sale of an issuer’s securities in certain limited circumstances without being considered a broker. Mr Blass stated his mistaken belief that that most private fund managers do not rely on Rule 3a4-1, which, in fact, they do. Blass suggests that private fund managers do not rely on this rule because in order to do so, a person must satisfy one of three conditions to be exempt from broker-dealer registration:
Mr Blass rightly points out that it would be difficult for private fund advisers to fall within these conditions. That, however, has not stopped most private fund managers from relying on some interpretation of the “issuer’s exemption” no matter how attenuated the adherence to the conditions might be.
Although Mr Blass indicated a willingness to work with the industry to fashion an exemption from broker dealer registration that is specifically tailored to private fund sales, he also reminded the audience that the SEC is quite willing to take enforcement action against private funds that employ unregistered brokers. Last month, the SEC settled charges in connection with alleged unregistered brokerage activities against Ranieri Partners, a former senior executive of Ranieri Partners, and an independent consultant hired by Ranieri Partners. The SEC’s order stated (whether or not supported by the facts) that Ranieri Partners paid transaction-based fees to the consultant, who was not registered as a broker, for the purpose of actively soliciting investors for private fund investments. This case demonstrates that there are serious consequences for acting as an unregistered broker, even where there are no allegations of fraud. The SEC believes that a fund manager’s willingness to ignore the rules or interpret the rules to accommodate their activities can be a strong indicator of other potential misconduct, especially where the unregistered broker-dealer comes into possession of funds and securities.
Private fund managers are encouraged to consider this statement and review their sales and compensation arrangements accordingly.
Originally published by InvestmentFundLawBlog
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