On September 26, 2013, David Blass, chief counsel in the Division of Trading and Markets at the Securities and Exchange Commission (“SEC” or “Commission”), and Bingham partners Amy Kroll and Rich Goldman participated in a Practicing Law Institute (“PLI”) webinar entitled, “Private Fund Sales and Marketing: A Conversation with Senior Staff from the SEC Division of Trading and Markets.”1 The starting point for the conversation was the speech given by Mr. Blass in April 2013 (“Speech”) in which he addressed private fund advisers and their need to be aware of broker-dealer regulatory requirements in the marketing of private fund shares by their employees and similar issues arising from transaction-based compensation paid to such employees.2
Mr. Blass stated that he had two goals in giving the Speech. First, he wanted to draw awareness to broker-dealer status issues arising in the private fund industry. This message is timely because, as a result of the enactment of the Dodd-Frank Act,3 many newly registered private fund advisers are going through initial SEC examinations and are being questioned about their marketing methods and processes. Mr. Blass noted that not all private fund advisers are aware of the intersection between fund marketing and broker-dealer status, so his Speech and the PLI webinar were part of an effort to “get the word out.”
According to Mr. Blass, the second purpose of the Speech was to begin a dialogue with the industry focusing on the private fund industry in order to tease out the issues that need to be addressed. The dialogue, according to Mr. Blass, has been robust since April as the Speech focused the attention of private fund advisers on their compensation practices and their marketing activities in comparison to other activities, including investor relations.
During the webinar, Mr. Blass emphasized that the Speech was not meant to signal that Staff was targeting private fund managers. He confirmed that while the Division of Trading and Markets regularly discusses the fund space with others at the SEC, private fund advisers are not currently a specific focus of enforcement attention with respect to their marketing activities. The Speech also was not meant to create new laws or rules — it was meant to raise awareness of existing laws and rules.
Mr. Blass confirmed that Staff, including individuals from the Division of Enforcement, regularly discuss the issues arising from marketing private funds and that participants in the discussions consider them a useful educational process. When asked by Ms. Kroll whether there is a “gotcha” mentality at the Commission with respect to marketing by private fund managers, Mr. Blass emphasized that the Staff’s goal currently is to put advisers on notice that this is an area of interest to regulators rather than an effort to “catch” fund managers.
According to Mr. Blass, Staff is considering two main questions in connection with private fund marketing:
Mr. Blass emphasized that the Staff is looking to apply a “rule of reason” in considering these questions.
When asked by Mr. Goldman if Staff should consider taking into account the sophistication of investors when analyzing whether broker-dealer registration is required, Mr. Blass responded that the Commission, except in the foreign broker-dealer context, has never used sophistication of the purchaser as a factor in determining if an entity’s activity would require it to register as a broker-dealer. However, Mr. Blass did acknowledge that considering the sophistication of an investor in a negotiated transaction may be worthwhile as the Staff considers whether it can provide some guidance in this area.
Mr. Blass reminded listeners that compensation paid to advisers from the funds they manage based on assets under management and/or investment performance, absent other factors, likely would not trigger a requirement to register as a broker-dealer. However, he did state that pure transaction-based compensation paid to an adviser’s employees is generally a “clear cut example” where registration would be required.
With respect to the application of the safe harbor for “associated persons” of an issuer under Exchange Act Rule 3a4-1, sometimes called the “issuer’s exemption,” Mr. Blass noted that the Staff is focusing on two areas:
Mr. Blass indicated he would favor a new rule written specifically for private fund advisers that would be similar to Rule 3a4-1. He acknowledged, however, that a rule proposal is unlikely in the near term, given other SEC rule-making obligations. Mr. Blass did indicate that he would be open to issuing guidance discussing some of the issues, possibly in the form of FAQs, much as Staff recently did with respect to Exchange Act Rule 15a-6 and in other areas of interest.4
Ms. Kroll noted that merger and acquisition and investment banking activities raise similar concerns to those Mr. Blass discussed with respect to private equity fund managers. Mr. Blass acknowledged that Staff is considering whether the “business broker” analysis currently under Staff consideration also might provide relief for some private equity fund activities.
Finally, Mr. Blass confirmed that managers outside the United States who market fund interests to U.S. investors in private placements and/or provide other “broker-dealer” services, need to consider whether broker-dealer registration is required. Mr. Blass confirmed that all managers, regardless of where they are located, should be concerned if they are soliciting U.S. investors.
Toward the end of the webinar, Mr. Blass highlighted a related area that the Staff has begun to scrutinize, specifically, whether the use of platforms for the sale of securities — which is allowable under the JOBS Act5 — would potentially raise broker-dealer registration issues. Mr. Blass acknowledged that the statute provides a new exemption from broker-dealer registration under Section 4(b) of the Securities Act of 1933. However, he focused on the limits to that statutory exemption. In particular, with the lifting of the ban on general solicitations in Rule 506 offerings, there seem to be many platforms developing that engage in solicitation and compensation practices that could raise broker-dealer status questions given the limited nature of the statutory broker-dealer registration exemption. Furthermore, Mr. Blass pointed out that platforms that create a secondary market for trading securities should consider whether exchange registration is necessary.
Mr. Blass cautioned that proper disclosures by the new platforms and their partners will be critical to provide clarity to investors seeking out these new marketplaces. Absent such disclosure, especially in situations where broker-dealers join together with platforms to offer securities, there is potential confusion for investors who may not understand the roles of the various parties and their respective responsibilities and limitations.
The question of broker-dealer status remains an important component in the analysis of all securities transactions. Mr. Blass’s speech and the recent webinar provide food for thought, though both leave the industry hungry for further clarity.
Contacts
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Kroll-Amy2 See the complete text of Mr. Blass’s Speech, “A Few Observations in the Private Fund Space,” (Apr. 5, 2013), at http://www.sec.gov/News/Speech/Detail/Speech/1365171515178. In the Speech, as well as at the beginning of the Webinar, Mr. Blass reminded listeners that “Before I get started…, please let me remind you that my remarks represent my own views, and not those of the Commission, any individual Commissioner, or any other members of the staff.”
3 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376.
4 See e.g., http://www.sec.gov/divisions/marketreg/faq-15a-6-foreign-bd.htm and http://www.sec.gov/divisions/marketreg/faq-cco-supervision-093013.htm.
5 Jumpstart Our Business Startups Act, Pub. L. No. 112-106, 126 STAT. 306.