Hedge funds and private equity firms are facing pressure to register as broker-dealers if they engage in what the SEC considers to be broker practices, such as receding traction-based compensation or advising on the merits of particular investment opportunities.
Recently, the SEC settled charges against Ranieri Partners, a New York-based private equity firm, and also with a former senior executive of Ranieri Partners and an independent consultant hired by Ranieri Partners.
The Commission’s order found 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.
“It is important for market participants to keep in mind that the willingness for one to act as an unregistered broker can be a strong indicator of other potential misconduct, especially where the unregistered broker-dealer comes into possession of funds and securities,” said David Blass, chief counsel of the SEC’s division of trading and markets, in a speech.
The Ranieri ruling carries great implications for private funds.
“The SEC said that if you send an offering document, you’re a broker-dealer, and if you solicit or prescreen investors, you’re a broker-dealer,” said Richard Heller, an attorney at Thompson Hine. “The ruling was so broad that it will add an additional burden to private funds. The consequences will be severe. Broker-dealer registration is not easy, and ongoing compliance is not easy, so it will create another layer of regulation in an already highly-regulated industry.”
The Dodd-Frank Act, and related SEC rules impose new registration and reporting requirements on private fund advisers. Many private fund advisers are coming to terms with the requirements under the Investment Advisers Act of 1940 that are newly applicable to them.
“While it is absolutely right and appropriate that private fund advisers devote their resources to complying with the requirements under the Advisers Act, I would like to be sure that the private fund adviser community is not overlooking activity that could cause a private fund adviser to be required to register as a broker-dealer,” said Blass.
Generally, the SEC’s determination of whether or not broker-dealer registration is required focuses on whether compensation is transaction-based, such as receiving contingent fees or any compensation tied to obtaining or completing a transaction.
Some examples of activities or factors that might require private fund adviser personnel to register as a broker-dealer include marketing securities (shares or interests in a private fund) to investors, soliciting or negotiating securities transactions, or handling customer funds and securities.
“Major private funds in the United States have launched their own captive broker-dealers to ensure compliance with SEC and Finra regulations,” said Heller.