SEC Enforcement Action May Clarify the Need of Private Equity Firms to Register as Broker-Dealers

On June 1, 2016, the Securities and Exchange Commission settled an enforcement action against a U.S. private equity firm finding, in part, that the firm acted as an unregistered broker-dealer because it sourced, structured and negotiated the acquisition of portfolio companies for the funds that it managed in-house and charged a success fee for its services without employing investment bankers or broker-dealers. The services performed by the private equity sponsor did not appear to be out of the ordinary and the transaction fees charged were expressly permitted by the fund’s limited partnership agreement.

The settlement order cited the receipt of transaction based compensation in the sale of securities as causing the private equity sponsor “to be acting as a broker” without registering under the Securities Exchange Act of 1934. This settlement order appears to be contrary to the position previously taken by the SEC in its no-action letter on this issue issued on January 31, 2014.  In the no-action letter, the SEC granted relief from the need for broker-dealer registration where a private equity firm sponsor assists in the sale of a private equity firm even where the firm was to receive transaction-based compensation; provided that numerous other factors were met.  It was viewed in the industry that the no-action letter put stock and asset based deals on parity with each other and that this issue had been put to rest.

The recent SEC enforcement action and the significant sanctions levied against the private equity firm should be of concern to any private equity sponsor which is not a registered broker-dealer and charges transaction-based fees upon closing.

This article is written by David Kern, Buckingham Business Partner and Partner-in-Charge of the Firm’s Akron office. To learn more about David, please click here.