United States: SEC Settles With Private Equity Fund Adviser Charged With Acting As An Unregistered Broker

Background

In a case that may reflect a notable change in the SEC's views on broker-dealer registration issues in the private equity industry, a private equity fund adviser agreed to settle SEC charges that it engaged in broker activity and charged brokerage fees without registration, and committed other securities laws violations. On June 1, 2016, Blackstreet Capital Management, LLC ("Blackstreet") was censured, and Blackstreet and its principal owner and managing member Murry N. Gunty agreed to cease and desist from further violations and pay more than $3.1 million to settle the proceeding.

Following an inspection and investigation, the SEC found that Blackstreet performed brokerage services for and received brokerage fees from portfolio companies, instead of using investment banks or registered broker-dealers to provide such services, and that Blackstreet and Mr. Gunty engaged in conflicted transactions, improperly used fund assets and failed to adequately disclose certain fees and expenses that were charged to the funds and/or the portfolio companies. In addition, the SEC determined that Blackstreet failed to adopt and implement reasonably designed compliance policies and procedures to prevent violations of the Investment Advisers Act of 1940 ("Advisers Act") and its rules arising from the alleged improper conduct.

Broker-Dealer Registration

The Securities Exchange Act of 1934 (the "1934 Act") defines a broker as "any person engaged in the business of effecting transactions in securities for the account of others." In determining whether a person is a broker, the SEC typically focuses on whether the person receives transaction-based compensation and participates in important parts of a securities transaction, including solicitation, negotiation or execution. According to the SEC order, Blackstreet provided brokerage services and received transaction-based compensation in connection with the acquisition and disposition of portfolio companies, which caused Blackstreet to be acting as a broker. The services included soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing, and executing the transactions. The settlement included disgorgement of transaction fees of $1,877,000, related prejudgment interest and a civil monetary penalty of $500,000.

The Blackstreet case is the first enforcement action in which the SEC has taken the position that the receipt of portfolio company transaction fees requires a PE adviser to register as a broker-dealer. The case appears to be a departure from previous public comments by the SEC Staff. In 2013, David Blass, then Chief Counsel of the SEC's Division of Trading and Markets, suggested that newly registered PE advisers preparing for their first SEC exam should consider whether any of their activities, including the receipt of transaction fees from portfolio companies, required broker-dealer registration. Blass said that if the fund management fee is "wholly" reduced by the transaction fees, there are no broker-dealer registration concerns, presumably because in that event the PE adviser is not being compensated for the brokerage services.

In public remarks later in 2013, Blass appeared to retreat from his position somewhat, stating that the SEC Staff would apply a rule of reason to the analysis of broker-dealer registration in the private equity industry. He noted similarities between PE advisers and M&A brokers, which typically facilitate transactions between buyers and sellers of operating business, with the buyer actively involved in the business after the acquisition. He said the Staff was considering registration relief for those brokers, and that such relief might have favorable implications for PE advisers. He suggested that this topic could also be the subject of informal Staff guidance in the future.

On January 31, 2014, the SEC's Division of Trading and Markets in fact did issue a no-action letter stating that "M&A Brokers," defined as persons engaged in the business of effecting securities transactions solely in connection with the transfer of ownership and control of private companies, could, subject to certain conditions, engage in that activity without broker-dealer registration. The letter was a significant departure from the SEC's long-held view that persons receiving transaction-based compensation in connection with acquisition transactions in securities must register. PE advisers do not necessarily fit within the no-action letter's definition of an M&A Broker, and may not satisfy some of the conditions set forth in the letter. Nevertheless, at the time of the M&A Brokers letter, it was thought by some commentators that, in light of the prior remarks by Mr. Blass, the letter might be good news for PE advisers receiving transaction fees from portfolio companies.

During this period, SEC examiners continued to raise the registration issue in examinations of newly registered PE advisers. In that connection, an industry group took the position that PE advisers provide investment advisory services and expertise to their affiliated funds and portfolio companies and do not engage in traditional broker-dealer activity such as widespread solicitation of investors, that receipt of transaction fees alone does not transform an investment adviser into a broker-dealer, that management fee offsets benefit fund investors, that in contrast to brokers which act as intermediaries, PE advisers have a significant economic stake in portfolio companies, and that PE advisers act as owners on behalf of their funds and portfolio companies.

Late in 2014, an SEC staffer commented on the transaction fee issue. He said the perception of the Division of Trading and Markets was that the industry had "self-corrected" to some extent, with the 100% management fee offset in some cases, and with running the fees through affiliated broker-dealers in others. He said the Division was mindful that this was a historic practice in the industry. He thought the best way to address it was through forward-looking guidance via a Q&A or a no-action letter and not through enforcement actions (at least in the absence of other unlawful conduct like bad disclosure and improper expense allocation).

Although the Blackstreet enforcement action does, as noted, include Advisers Act violations, the SEC's press release clearly emphasizes the failure to register and includes the following statement by Andrew J. Ceresney, Director of the SEC Enforcement Division: "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. Blackstreet clearly acted as a broker without fulfilling its registration obligations."

An SEC administrative proceeding settlement does not have precedential value and of course depends on the facts of the case. However, the order suggests that the SEC now may not see any distinction between the activities of PE advisers and other persons engaged in the business of effecting securities transactions for others and therefore subject to registration. To that extent, prior Staff comments with implications to the contrary should be questioned. It now appears that the SEC may apply traditional broker-dealer analysis to the registration question for PE advisers, which is hard to square with the policy judgment presumably underlying the M&A Brokers no-action letter that brokerage activity in connection with change in control transactions of private companies does not require registration.

Both the SEC press release and order state that Blackstreet received compensation for the broker services provided to its portfolio companies. Notably, the Blackstreet case does not appear to involve failure to disclose such compensation to investors; the order observes that the fund agreements at issue "expressly permitted [Blackstreet] to charge transaction or brokerage fees." The Blackstreet order does not indicate that management fees for the Blackstreet funds were subject to any transaction fee offset. For this reason, the status of prior Staff comments that a 100% management fee offset obviates the need for broker-dealer registration is uncertain. At a minimum, care should be taken that a PE adviser not registered as a broker-dealer is not receiving other forms of compensation for brokerage services rendered to portfolio companies.

The SEC may have been emboldened in pursuing the broker-dealer registration issue with Blackstreet by the explicit reference to brokerage services in the Blackstreet fund agreements, as well as by the seemingly questionable conduct underlying the other securities law violations summarized below. However, in the wake of the Blackstreet action and the absence of any forward-looking guidance from the SEC, PE advisers should carefully review their activities to determine whether registration is required. The risks of failing to register when required include disgorgement of transaction fees, penalties, interest, and censure and cease and desist orders. In addition to these administrative remedies, the SEC can also resort to the courts and seek a permanent or temporary injunction as well as civil penalties. The 1934 Act also imposes liabilities on controlling persons and persons who aid and abet others who violate the 1934 Act. In theory, the SEC could ask the Department of Justice to institute criminal proceedings. As most states have their own statutes requiring broker-dealer registration, state enforcement actions could also result. Finally, a transaction in which an unregistered broker is involved could be subject to rescission in a private action under the 1934 Act or similar state laws.

Other Securities Law Violations

In addition to the unregistered broker-dealer claims, the SEC found that Blackstreet and Mr. Gunty engaged in other violations of securities laws, including:

  • Blackstreet charged at least $450,000 in "operating partner oversight fees" to portfolio companies without properly disclosing that it may receive such fees. It is worth noting that the persons performing operating partner services were current employees of Blackstreet and that the portfolio companies paid Blackstreet directly for their services.
  • Blackstreet used fund assets to pay for political contributions to a state campaign, charitable contributions and entertainment expenses (including a lease and event tickets), even though such expenditures were not authorized in the funds' governing documents. The SEC further noted that Blackstreet neither sought, nor obtained, appropriate consent for this use of fund assets.
  • Blackstreet acquired a departing employee's interest in certain portfolio companies even though the fund's governing documents required the interest to be repurchased by the portfolio companies for the benefit of the funds and its investors. In addition, Blackstreet failed to disclose its own financial interests or obtain appropriate consent to engage in the transaction.
  • Mr. Gunty indirectly (through an entity he controlled) acquired fund interests from certain defaulting and selling limited partners despite the fact that the fund's governing documents required the defaulting limited partners to forfeit their interests back to the funds. Following the acquisition, Mr. Gunty caused the fund's general partner (which he also controlled) to waive his obligation to make future capital calls associated with his newly acquired interest.1 Both the acquisitions and waivers were inconsistent with the terms of the fund's governing documents and the SEC found that Blackstreet's subsequent failure to disclose these waivers rendered the fund's governing documents materially misleading.
  • Blackstreet failed to adopt and implement policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules arising from the improper use of fund assets, undisclosed receipt of fees and engaging in other transactions that involve conflicts of interest.

The SEC's press release is available here and a copy of the SEC's order is available here.

Footnote

1. The SEC's order noted that notwithstanding the fact that Mr. Gunty did not participate in the gains resulting from these new investments, the failure to make future capital calls reduced the capital available for investment opportunities, thereby increasing the pro rata share of future capital calls borne by the remaining limited partners.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.