Broker-Dealer Violations by Private Equity Fund Adviser

By Eric Mikkelson

For private equity funds, along with their managers, sponsors, investors, and portfolio companies paying or receiving transaction-based fees, the recent announcement by the Securities and Exchange Commission (SEC) of a settled enforcement action should be a reminder of the necessity to comply with applicable broker-dealer registration and compliance rules.

The charges included receipt by the fund adviser of transaction-based compensation in exchange for brokerage services it provided with respect to the acquisition and disposition of the fund's portfolio companies. The fund manager was registered with the SEC as an investment adviser, but was not registered as a broker. As part of the SEC's order, over $3.1 million was ordered paid in disgorgement, penalties and interest.

While there were several other charges that undoubtedly brought additional scrutiny to the unregistered broker issues, provision of these types of "brokerage" services by private fund managers and affiliates who are not registered as brokers may not be rare. The unregistered broker services performed in exchange for transaction-based compensation noted in this case included 1) soliciting deals; 2) identifying buyers or sellers; 3) negotiating transactions; 4) structuring transactions; 5) arranging financing; and 6) executing the transactions.

For a few years now, the SEC and the Financial Industry Regulatory Authority (FINRA) have been warning of enhanced regulatory scrutiny coming to this area. It has apparently arrived.

A link to the SEC order, published June 1, 2016 (sanctioning Blackstreet Capital Management, LLC and its managing member), can be found here.

For more information, or to discuss related compliance and risk management strategies, please contact any member of Stinson Leonard Street's Investment Management Practice Group.

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