After years of rumblings and rumors that the Securities and Exchange Commission might eventually provide clarity on whether private equity managers and others must register as securities brokers, it appears that any clarity will come from the SEC’s Enforcement Division filing lawsuits rather than other divisions proposing rule changes or providing guidance.

The most recent action came on June 1, when the SEC sued Maryland-based PE fund advisor Blackstreet Capital Management for handling the acquisition and disposition of portfolio companies—a role the SEC alleged should required Blackstreet to register as a securities broker. 

According to the SEC, Blackstreet collected fees for services such as “soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing, and executing the transactions.” The SEC characterized the $1.8 million received by Blackstreet for these services as “transaction based compensation,” a key factor in determining whether an advisor is acting as a broker.

Blackstreet’s limited partnership agreements expressly permitted Blackstreet to charge transaction or brokerage fees, suggesting perhaps that Blackstreet did not believe or understand that it needed to register as a broker. Nevertheless, rather than challenging the SEC’s allegations, Blackstreet agreed to settle the matter, paying nearly $3 million in disgorgement and penalties.

The PE/broker registration issue arose with a bang in 2013 when the SEC brought an enforcement action against private equity firm Ranieri Partners and related parties in connection with solicitation of over $500 million in capital commitments and a month later a senior SEC official gave a speech that alarmed some in the PE community by suggesting that PE advisors acted in the capacity of brokers when they marketed interests in private funds or collected transaction-based fees in connection with portfolio company transactions.

An obvious way for the SEC to reduce or eliminate alarm and ambiguity on the issue would have been to implement rules or issue no-action letters, but the SEC’s furtive attempts in this area over the past several years have not brought much in the way of clarity. 

In February 2014, the SEC issued a no-action letter with respect to “M&A brokers” who broker the sale and purchase of businesses, indicating that persons in that business may advice without registering as brokers even when the brokers receive transaction based compensation. 

In June 2015, a member of the SEC Advisory Committee on Small and Emerging Business Committee submitted commentary to the Committee offering his view that the broker-dealer registration process was too onerous for finders or small intermediaries that could potentially assist in offerings for small and emerging businesses.

In September 2015, the Committee submitted formal proposals to the SEC Chair recommending, among other things, that the SEC “take steps to clarify the current ambiguity in broker-dealer regulation by determining that persons that receive transaction-based compensation solely for providing names of or introductions to prospective investors are not subject to registration as a broker under the Securities Exchange Act.” There has been no further comment from the SEC with regard to these proposals.

Due to the unsettled law in this area, at least one PE firm chose to challenge the SEC’s allegations in court.  Earlier this year, Donald Lester and his Colorado-based private equity firm Rubicon asked a Colorado federal court to throw out the SEC’s allegations, charging them with failing to register as securities brokers for soliciting investments in two funds managed by Rubicon with an eye toward investing in renewable energy assets.

In asking the court to dismiss the broker registration charge, Rubicon and Lester argued that the compensation at issue was not “transaction based.”  Rather, they claimed, the compensation related to enumerated consulting services on a monthly basis subject to adjustment roughly based on the magnitude of a portfolio company’s operations along with reimbursement for various expenses, and an hourly rate for additional services.

The SEC opposed Lester and Rubicon’s motion to dismiss the unregistered broker claims, and the matter is set to be heard in July.  Unfortunately for those hoping for “clarification through litigation” on these issues, this case will not bear fruit:  the parties report that they are having “productive” settlement discussions, which would also deprive the rest of us of the opportunity to put the SEC’s aggressive legal position to the test with at least one federal judge.  In the absence of such a test, unregistered PE advisors should proceed with caution in connection with soliciting interests in the funds they manage and in collecting fees related to portfolio company transactions.

Jenifer Doan, an attorney with Zaccaro Morgan, contributed