In its scrutiny of newly registered private fund advisers, the SEC Staff has observed two practices that might implicate broker-dealer registration requirements.
The first practice involves fund advisers that pay their personnel transaction-based compensation for selling interests in their funds or that have personnel whose primary purpose is selling interests in the funds. The second practice involves private fund advisers, their personnel, or their affiliates receiving transaction-based compensation for purported investment banking or other broker activities relating to one or more of the funds’ portfolio companies.
The receipt of transaction-based compensation has long irritated the SEC, and it believes it is the quintessential aspect of being a broker. The failure to properly register as a broker-dealer may have serious consequences, including, but not limited to, being sanctioned by the SEC, or having the securities transaction in question rescinded. When private fund advisers are selling interests in their funds, they should consider certain questions when they obtain new investors and retain existing investors. The advisers also should consider if employees, who solicit investors, have other responsibilities, and the method of payment. These are the same factors that the SEC Staff considers when trying to determine if a person or entity is a broker-dealer.
As to the second type of practice, it is common for advisers of certain types of funds—such as private equity funds that execute a leveraged buyout strategy—to collect others fees in addition to advisory fees. Some of those other fees call into question if the advisers are engaging in broker-dealer activities.
As such, private fund advisers must be aware of the SEC’s concerns.