SEC Chief Counsel David Blass Clarifies When Private Fund Employees Are Required to Register as "Brokers" (with Lofchie Comment)

David W. Blass, Chief Counsel of the SEC Division of Trading and Markets, delivered a speech discussing when a firm or individual is required to register with the SEC as a broker-dealer, with particular application to private funds.

David Blass discussed two broker-dealer issues relevant to funds: (i) are the fund's employees who talk to potential new investors in the fund effectively acting as securities "brokers" who should be registered as such (or affiliated with a firm that is registered as such) (the "Marketing Issue"); and (ii) in the private equity/venture world, is an advisor who puts together a capital transaction and receives a fee or other benefit as a result of that transaction acting as an investment banker who should also be registered as a broker (the "I-Banking Issue")?

Marketing Issue: Last month, a story appeared in the Cabinet as to an SEC disciplinary action against, among others, an adviser who had hired an unregistered broker to market securities issued by funds managed by that adviser. See SEC Charges Private Fund, Fund Officer and Employee for Activities as an Unregistered Broker (with Lofchie Comment). That story raised a question as to whether this was (i) a one-off disciplinary action in light of the fairly bad facts of the case or (ii) an indicator that the SEC would look much more closely at the sales activities of private funds generally. Mr. Blass says that the latter is the case. In fact, the views that he asserts in the speech go well beyond the facts of the recent case. Most significantly, he asserts that the employees of an advisor who are primarily engaged in activities relating to potential investors may very well be brokers.

I-Banking Issue: As to the I-Banking issue, Mr. Blass raises two distinct problems. First, is the adviser who receives some benefit acting as a broker? Second, is the adviser acting properly from a fiduciary standpoint in taking the benefit or is there an improper conflict of interest?

Lofchie Comment: Private funds and their advisers should closely and promptly review their marketing practices and their I-banking practices in light of Mr. Blass's remarks. Advisors should consider whether their current marketing practices should be revised, and whether they should register an entity as a broker-dealer (which is a process that takes a while to complete).

In reviewing their current practices, advisers should be aware that, as a matter of law, Mr. Blass did not say anything that was novel or that would change the written law or SEC informal interpretation. Rather, he was saying that the SEC was likely to begin enforcing the written law in a market (i.e., the private fund market) where it has not done so previously. This development was likely inevitable once private fund advisers generally were required to register with the SEC. That is, the increased examination of private funds by SEC staff would inevitably bring to the attention of the SEC situations where advisory employees, or the advisors themselves, were arguably acting as securities brokers.

Interestingly, as to the Marketing Issue, Mr. Blass did suggest that an exemption could be developed for private fund advisers marketing their own funds. I would certainly urge the private fund industry to explore the possibility of this exemption with the SEC staff, albeit with a couple of cautions. First, obtaining such an exemption, if it can be done at all, will take some time; it is thus not a solution for any current activities that may be problematic. Second, any such exemption would inevitably be subject to conditions; e.g., recordkeeping, qualifications of the marketing people, etc., that will need to be carefully considered by both the fund industry and the SEC.

View speech in full here (links externally to SEC website).
See also: Lofchie's Guide to Broker-Dealer Registration, Registration Requirement Chapter.

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