Why PE is Bracing for Mass Broker-Dealer Registration

A new SEC ruling could have costly implications for private equity dealmakers

On June 1, the SEC announced a $3.1M settlement with Blackstreet Capital Management and its leader over charges that the firm acted as a broker-dealer without obtaining the necessary registration. The SEC’s action has potentially broad implications for private equity’s status quo, where general partners often earn fees for negotiating transactions to acquire and sell portfolio companies.

“This unsettles the legal landscape,” explains Neil Freeman, partner with law firm Purrington Moody Weil LLP. “Any manager considering [taking investment banking fees from portfolio companies] should do so with their eyes wide open, because they are at risk of an enforcement action.”

The SEC’s action appears to run counter to the prevailing view that GPs don’t need to register so long as they reduce the management fee they charge their LPs by an amount equal to any transaction fees they earn. Until recently, GPs have relied on statements made three years ago by David Blass, then the chief counsel to the SEC’s Division of Trading and Markets, who said that such fee offsets meant that fund managers ultimately received no compensation for their investment banking services and, therefore, didn’t need to register as a broker-dealer.

The recent settlement and SEC statements call that all in to question.

“The rules are clear: before a firm provides brokerage services and receives compensation in return, it must be properly registered within the regulatory framework that protects investors and informs our markets,” Andrew Ceresny, director of the SEC Enforcement Division, said in a press release.

The Blackstreet settlement made no mention of fee offsets, leaving GPs to wonder whether they risk running afoul of the SEC by doing business as usual. Smaller PE funds would be the hardest hit by the change given the time and money it takes to become a registered broker dealer.

It’s anyone’s guess when and if the SEC will clarify its position, but Freeman expects investors will have more information in the next few years. Market practice will eventually settle into a new normal, but until that happens, Freeman recommends managers “proceed with caution.”