May 25, 2020

Private Equity Firms: Potential Broker-Dealer Issues

The SEC has become increasingly focused on investigating whether private equity sponsors are engaging in activities that would require them to register as broker-dealers under the Securities Exchange Act.  Section 3(a) of the Exchange Act defines a broker as “any person engaged in the business of effecting transactions in securities for the account of others” and a dealer as “any person engaged in the business of buying and selling securities for such person’s own account.”  David Blass, Chief Counsel of the SEC’s Division of Trading and Markets, stated recently that the SEC staff noted that some fund sponsors are: (1) paying transaction-based compensation to fund personnel for marketing fund interests and/or (2) receiving transaction-based compensation for supposed investment banking or other broker activities relating to one or more of a fund’s portfolio companies.[1]  According to Blass, receiving transaction-based compensation is a “hallmark” of being a broker-dealer; he suggested that fund sponsors review these areas of concern prior to an SEC examination.

Marketing of Fund Interests

Blass pointed to a recent SEC enforcement action against a private equity firm, Ranieri Partners, to illustrate the problems for private equity firms surrounding fundraising and marketing fund interests. The SEC found that Ranieri Partners had violated the broker-dealer registration provisions under the Exchange Act because the firm had paid transaction-based compensation to a consultant that actively solicited private fund investors but the consultant was not registered as a broker-dealer.[2]  The SEC ultimately reached a settlement with Ranieri Partners in connection with this enforcement action.  In addition to penalties against the fund sponsor and the consultant, Blass suggested that the fund investors may have the right to rescind their investments in the fund because the transactions were conducted by an unregistered broker-dealer.  He stated that this case and others like it demonstrate the “serious consequences for acting as an unregistered broker, even where there are no allegations of fraud.”

Some private equity firms have explored reliance on the “issuer exemption” under Rule 3a4-1 of the Exchange Act, which provides a nonexclusive safe harbor under which associated persons of certain issuers can participate in the sale of an issuer’s securities without being considered a broker.  According to Blass, private equity firms have not been able to make use of this safe harbor because it is difficult for such firms to meet one of the conditions necessary to claim the exemption from registration. Those conditions include: (1) limiting the offering and selling of securities only to broker-dealers and other specified types of financial institutions; (2) performing substantial duties other than in connection with transactions in securities and not participating in selling an offering of securities more than once every 12 months; and (3) limiting activities to the delivery of written communication by means not involving oral solicitation by the associated person of a potential investor.

Investment Banking Activities

Another area that Blass addressed was the receipt of compensation by private equity firms in connection with investment banking-type services provided to their portfolio companies, such as negotiating transactions, identifying and soliciting purchasers or sellers of the securities of the company, or structuring transactions. Blass stated that receiving transaction-based compensation for these investment banking services may cause a fund sponsor to be considered a broker as the fund and the sponsor can be considered distinct entities with distinct interests.  Blass explained that if a sponsor receives transaction-based compensation, it has a stake in the transaction, which could be a conflict of interest that broker-dealer dealer registration is designed to address.  However, he noted that if the fund sponsor’s advisory or management fee is wholly reduced by the transaction-based compensation, there are no broker-dealer registration concerns.

[1] David W. Blass, A Few Observations in the Private Fund Space, Address Before the Trading and Markets Subcommittee of the American Bar Association, Washington, D.C. (Apr. 5, 2013), available at:

[2] Ranieri Partners LLC, Exchange Act Release No. 69091 (Mar. 8, 2013).

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About this Author

David Denious, Corporate Finance Lawyer, Drinker Biddle

David S. Denious advises clients on leveraged acquisitions and dispositions and corporate finance transactions. Dave represents a wide variety of private equity firms, family offices and similar financial sponsors on leveraged buyout, "going private," recapitalization, and other control transactions and the debt and equity financing relating to such transactions. He also has extensive experience representing both investors and issuers in growth capital and other non-control equity investments. In addition, Dave has counseled numerous strategic clients on...

Neil Haimm, Mergers & acquisitions lawyer, Drinker Biddle

Neil K. Haimm assists private equity firms and public and private companies with mergers and acquisitions, joint ventures and other strategic transactions, as well as venture and growth capital investments.

Neil has more than 30 years of experience as a corporate lawyer.

John Stoddard, Business attorney, Drinker Biddle

John E. Stoddard III has advised businesses and their officers, directors and owners on a broad range of legal and business matters for over three decades. He assists private equity firms and middle-market companies on transactional work such as mergers and acquisitions, divestitures, leveraged recapitalizations, private placements and joint ventures, throughout the U.S. and internationally. Utilizing his broad experience and hands-on approach, John focuses on providing practical, cost-effective solutions that address the legal and business needs of...