Once a loosely regulated bunch, private equity firms might have to register as broker-dealers or find their ability to charge transaction fees or provide bank-like services impaired. These are the very services that help them attract portfolio companies.
The Securities and Exchange Commission rocked the private equity world last month when agency officials settled with private equity firm Blackstreet Capital Management for $3.1 million, signaling in a three-page agreement that if private equity firms want to charge transaction fees, they might have to register. According to the June 1 settlement, Blackstreet ran afoul of regulators by engaging in brokerage activity related to the acquisition and disposition of portfolio companies without registering as a broker-dealer.
Private equity firms perform a number of services for their portfolio companies, such as help them raise capital and assist with mergers and acquisitions.
Registration as a broker-dealer is not something private equity firms are eager to do because it is an expensive process and opens these firms up to another set of regulations and regulators, industry insiders and lawyers say. In order to avoid broker-dealer registration, many private equity firms have been offsetting as much as 100% of transaction fees against the management fees and/or carried interest.
“The new concern arising from Blackstreet is that private equity firms may need to become registered as broker-dealers if they engage in investment banking activities for their portfolio companies,” said David Fann, president and CEO of San Diego-based private equity consultant TorreyCove Capital Partners LLC. “This could be a new chapter of regulatory oversight for some private equity firms.”
The issue of registration first came up in a 2013 speech to the American Bar Association by David Blass, then chief counsel in the SEC's division of trading and markets who mentioned that private equity firms were charging transaction fees for investment banking and other banking services. In 2014, the SEC released a no-action letter on the issue, which provided limited relief only for brokers that solely worked on mergers and acquisitions, making relief generally unavailable to most private equity firms, according to a June 21 memo on the issue by law firm Winston & Strawn LLP.