SEC Trading and Markets Chief Counsel Comments on Private Fund Sales and Marketing

April 08, 2013

David Blass, the Chief Counsel in the Division of Trading and Markets at the U.S. Securities and Exchange Commission, spoke on Friday, April 5, to the American Bar Association, Business Law Section, Trading and Markets Subcommittee. Blass addressed several areas on which the staff has focused in considering the circumstances in which a person is required to register as a broker-dealer. The majority of Blass’s comments, which were published on the SEC’s website later that day, related to questions of when a private fund, its adviser and personnel need to consider whether broker-dealer registration is required. While Blass’s remarks clearly were cautionary, he tempered them in two ways. First, he recognized that each situation is fact-specific. Second, Blass expressed hope that the industry and the SEC (and SEC staff) would collaborate on ideas for exemptive relief, to the extent needed, for certain private fund sales activities. This contemplated relief would supplement existing relief, such as the “issuer’s exemption” reflected in Rule 3a4-1 adopted under the Securities Exchange Act of 1934 (“Rule 3a4-1”), that may be of limited utility to private funds, their advisers and personnel.1

Private fund advisers may wish to evaluate their sales and marketing activities in light of Blass’s comments, especially newly registered investment advisers awaiting their first SEC examination.

Words of Caution

Blass acknowledged that private fund managers are still addressing the new registration and reporting requirements under the Investment Advisers Act of 1940 (“Investment Advisers Act”). He noted that with registration comes SEC examinations, and that the SEC staff’s increased focus on potential broker-dealer registration issues at private fund managers is driven in part by practices that the examination staff already has seen in their early cycles of investment adviser examinations. Therefore, Blass couched his comments as intended to help private fund advisers to understand where potential concerns reside in sales and marketing activities, and to review these activities before examiners arrive. Blass pointed to what he described as two “flavors” of activities that funds and their advisers should consider in evaluating potential broker-dealer status (in his words “plain vanilla” issues and “dark chocolate with a subtle infusion of habañero” issues).

Plain Vanilla: Sales of Interests in Private Funds

Blass first focused on solicitation of investors for, and sales of interests in, private funds. He gave three examples of activities that, under some circumstances, could cause a private fund adviser’s personnel to be acting as an unregistered broker-dealer — (1) marketing securities (shares or interests in a private fund) to investors, (2) soliciting or negotiating securities transactions, or (3) handling customer funds and securities. Blass noted that “[t]he importance of each of these activities is heightened where there also is compensation that depends on the outcome or size of the securities transaction — in other words, transaction-based compensation...” The “SEC and SEC staff have long viewed receipt of transaction-based compensation [as] a hallmark of being a broker,” Blass said.

Blass noted that, in March, the SEC sanctioned Ranieri Partners, a private equity fund, a former senior executive of Ranieri Partners and an independent consultant hired by Ranieri Partners, finding that Ranieri Partners paid transaction-based fees to the consultant, who was not registered as a broker, to solicit actively investors to invest in Ranieri Partners’ private fund.2

Blass framed four questions an adviser should answer in considering whether an adviser (or fund) and its personnel might be acting as an unregistered broker:3 

  • How does the adviser solicit and retain investors? Blass recommended that an adviser consider the duties and responsibilities of personnel soliciting and/or marketing to prospective investors. He noted that employees working within a “marketing” department and dedicated to sales could be considered in “the business of effecting transactions” in the private fund, regardless of how they are compensated.
  • Do employees who solicit investors have other responsibilities? If so, consider what those responsibilities are. Generally, if the primary responsibility of employees is to solicit investors, the concerns raised in the first bullet above must be considered, Blass indicated.
  • How are personnel who solicit investors for a private fund compensated? Do those individuals receive bonuses or other types of compensation that is linked to successful fund raising? As previously noted, Blass identified the existence of transaction-based compensation as a critical element to a determination of whether broker-dealer registration is required.
  • Does the fund or adviser charge a transaction fee in connection with securities transactions? In addition to considering compensation of employees, advisers also must consider the fees they charge and in what way, if any, they are linked to a securities transaction (more on this topic below).

Dark Chocolate With a Subtle Infusion of Habanero: Practices Within the Fund

Blass also drew an analogy between some activity by advisers in connection with the purchase or sale of a portfolio company and investment banking activity. For example, an adviser should focus on “fees the manager directs a portfolio company of the fund to pay directly or indirectly to the adviser or one of its affiliates in connection with the acquisition or disposition (including an initial public offering) of a portfolio company or a recapitalization of the portfolio company. These fees may be described as compensating the private fund adviser or its affiliates or personnel for ‘investment banking activity,’ including negotiating transactions, identifying and soliciting purchasers or sellers of the securities of the company, or structuring transactions.”

Fees for these activities, when linked to effecting the securities transaction, “appear, at least on their face, to cause such an adviser to fall within the meaning of the term ‘broker.’”

Blass acknowledged that in some instances, these fees likely are permissible, for example, “where the payments offset or otherwise reduce the amount of the advisory fee payable by the fund.” Using the transaction fee “as another way to pay the advisory fee,” Blass offered, “would not appear to raise broker-dealer registration concerns.” Blass, however, was less sympathetic to the argument that fees received by the adviser, as general partner of the fund, are being received by the fund itself. According to Blass, “[t]his explanation does not seem plausible...if the general partner and the fund are the same, why is it that the fee is paid to anyone other than the fund. That the fee is paid to someone other than the fund...makes crystal clear to me that, at least for potential broker-dealer status questions, the fund and the general partner are distinct entities with distinct interests.”

Whipped Cream and a Cherry: Offers for Dialogue

Throughout his informal spoken comments, and in his published comments, Blass stated that the SEC staff was eager to discuss these issues further with fund advisers to understand their perspective and to explore the boundaries of permissible conduct. Blass further allowed that the staff has been considering taking action to broaden the scope of the “issuer exemption” under Exchange Act Rule 3a4-1 at least in part to craft an exemption that would cover some of fund advisers’ conduct in this area beyond that already contemplated by the Rule 3a4-1.

Blass’s comments should be a useful tool for advisers considering how to structure efforts to solicit investors and sell investments in private funds and portfolio companies of private equity funds. As Blass noted in his published remarks, but strongly emphasized in his informal spoken remarks, the SEC and its staff, including the Division of Enforcement, are now willing and able to bring cases, such as Ranieri, that address failures to register as a broker-dealer. Therefore, fund advisers should use this opportunity to consider how they structure their sales and marketing arrangements, to assess the likelihood of SEC examiner scrutiny of their particular practices, and to develop a response, in the event of attention on sales practices. Blass’s comments may lead some fund advisers to revisit their sales and marketing programs, and to revise them to address any areas identified that could give rise to concern.


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1 A Few Observations in the Private Fund Space, David Blass, Chief Counsel, Division of Trading and Markets
U.S. Securities and Exchange Commission, American Bar Association, Trading and Markets Subcommittee
Washington, D.C. (April 5, 2013).

2 In the Matter of Ranieri Partners LLC and Donald W. Phillips, Administrative Proceeding File No. 3-15234 (March 8, 2013). 

3 Blass noted that personnel at many advisers to private funds ordinarily are not able to fall within the safe harbor under Securities Exchange Act Rule 3a4-1 (the so-called “issuers exemption”) because they often engage in activities beyond those  addressed  in the rule.  Blass acknowledged that Rule 3a4-1 is a “non-exclusive safe harbor” and that certain advisers and their personnel likely have structured their activities to avoid broker-dealer status even if technically outside the safe-harbor.

This article was originally published by Bingham McCutchen LLP.