United States: SEC Enforcement Action Highlights Need For PE Fund Advisers To Address Potential Broker-Dealer Issue

On June 1, 2016, the Securities and Exchange Commission (the "SEC") filed and settled an administrative proceeding against Blackstreet Capital Management, LLC ("Blackstreet") and Murry N. Gunty, the principal owner and managing member of Blackstreet ("Gunty").1 In order to settle the proceeding, Blackstreet and Gunty agreed to pay approximately $3.1 million. This settlement order highlights the SEC's continued focus on the private equity fund space and, in particular, evidences the SEC's renewed interest in the receipt of transaction fees by private equity fund advisers as part of a determination of whether such advisers may need to register as broker-dealers.

Enforcement Action

In this enforcement action, the SEC alleged violations by Blackstreet and Gunty relating to

  1. the receipt of transaction-based compensation for the provision of brokerage services in connection with the acquisition and disposition of portfolio companies, while not being registered as a broker;
  2. the collection and receipt of certain unauthorized and inadequately disclosed fees in one of the Blackstreet-advised funds. In particular, Blackstreet charged oversight fees to two portfolio companies owned by the operating partner of one of its funds, even though the fund's governing documents did not expressly authorize Blackstreet to charge such fees and such fees were not disclosed to the fund's investors until after Blackstreet received the fees;
  3. the unauthorized use of fund assets to make political contributions and pay for entertainment expenses and the failure to adequately track whether entertainment expenses were for business or personal use;
  4. the unauthorized purchase by Blackstreet of portfolio company interests from a departing employee, which should have been repurchased by the portfolio companies for the benefit of the funds and its investors; and
  5. the purchase by Gunty of limited partnership interests from defaulting investors. Under the terms of the fund documents, the interests should have been forfeited back to the relevant funds. In addition, once he had acquired the interests, Gunty waived (through the general partner) his obligation to satisfy future capital calls on any new investments in one of the funds, contrary to the terms of the fund's governing documents.

Industry Reaction

The private equity fund industry has taken note, in particular, of the claim that Blackstreet violated broker-dealer registration requirements when it performed brokerage services on behalf of fund portfolio companies. The SEC noted in its action that Blackstreet provided brokerage services with respect to the acquisition and disposition of portfolio companies, "including soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing and executing the transactions" in-house rather than employing investment banks or broker-dealers to perform such services.

The SEC's focus on this issue was initially highlighted in a 2013 speech by David W. Blass, then Chief Counsel of the SEC's Division of Trading and Markets.2 Mr. Blass highlighted the potential need for broker-dealer registration (1) in connection with private fund capital-raising activities and (2) in instances where a private fund adviser, its personnel or its affiliates receive transaction-based compensation for purported investment banking or other brokerage activities relating to one or more of the fund's portfolio companies. Presumably, Blackstreet fell into the broker-dealer registration net due to what the SEC perceived as its regular and active participation in securities transactions, especially at key points in the chain of distribution, and the fact that it received compensation with respect to these transactions that was tied to the completion of the securities transaction (i.e., transaction-based compensation), all of which are badges of broker-dealer activity.

It is common for private equity fund advisers to offset transaction fees against advisory fees. Mr. Blass noted such offsets in his 2013 speech and said "to the extent the advisory fee is wholly reduced or offset by the amount of the transaction fee, one might view the fee as another way to pay the advisory fee, which, in my view, in itself would not appear to raise broker-dealer registration concerns." It is unclear from the Blackstreet enforcement action if Blackstreet utilized a partial or full offset, so there is uncertainty as to whether the SEC continues to support this approach, or if such offsets would no longer help advisers avoid broker-dealer status.

The SEC's focus on fees and expenses and related conflicts was highlighted again on May 12, 2016, by Andrew Ceresney, Director, Division of Enforcement,3 during a speech in San Francisco. Mr. Ceresney noted in that speech that the SEC's actions against private equity fund advisers fall into three interrelated categories: (1) advisers that receive undisclosed fees and expenses, (2) advisers that impermissibly shift and misallocate expenses, and (3) advisers that fail to adequately disclose conflicts of interest, including conflicts arising from fee and expense issues.

It should be noted that the action against Blackstreet touched on the three areas highlighted by Ceresney in his speech.In addition, the broker-dealer registration focus was reemphasized as recently as June 7, 2016 when Robert B. Baker, the assistant regional director at the SEC's enforcement division's asset management unit, indicated that "[a]ny private equity adviser that doesn't have a broker-dealer registration and is earning transaction fees – I'm not saying that is a violation – but it creates a question."


It is clear from the Blackstreet settlement and Andrew Ceresney's and Robert Baker's recent speeches that the SEC is still focused on the receipt of transaction fees by private equity fund advisers and fee and expense/conflict of interest issues in the private equity fund industry. Considering the potentially large civil penalties that can be levied by the SEC and applicable state regulatory authorities as well as the risk of a private action for rescission, private equity fund advisers should carefully review their (1) transaction fee structures and agreements related thereto so as to try to avoid these arrangements being classified as brokerage services where the service provider receives transaction-based compensation in order to eliminate the need to register as a broker-dealer and (2) disclosures regarding such fees and related expenses and any related conflicts of interest.


1 In the Matter of Blackstreet Capital Management, LLC and Murry N. Gunty (June 1, 2016).

2 A Few Observations in the Private Fund Space, Address at the Trading and Markets Subcommittee Meeting of the American Bar Association (Apr. 5, 2013).

3 Securities Enforcement Forum West 2016 Keynote Address: Private Equity Enforcement (May 12, 2016).

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.

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