The SEC is continuing its pattern of establishing “standards of conduct” for the private equity industry through speeches, enforcement actions, and public settlements. After foreshadowing its concerns in various speeches over the last three years, the SEC recently returned its attention to the “unregistered broker” issue. In a settlement announced last week, the SEC asserted that a private equity manager was acting as an “unregistered broker” in connection with certain portfolio company transactions. Based on this publicly announced settlement, private equity fund managers should evaluate carefully whether the nature of services that they may provide, and the compensation that they may receive, related to portfolio company transactions may give rise to an obligation to register as a “broker.”
On June 1, 2016, the SEC announced a settlement with Blackstreet Capital Management, LLC and Murry N. Gunty, Blackstreet’s managing member and principal owner. As a registered investment adviser based in Chevy Chase, Maryland, Blackstreet provides investment advisory and management services to two groups of private equity funds (the Blackstreet funds), each in turn sponsored by affiliated Blackstreet Capital general partners. While neither admitting nor denying the SEC’s allegations (which included additional regulatory charges), Blackstreet and Gunty agreed to pay approximately $3.12 million to settle the charges, which consisted of approximately $2.6 million in disgorgement (including pre-judgment interest) and a $500,000 civil monetary penalty.
Blackstreet was neither registered with the SEC as a broker, nor had it ever been affiliated with a registered broker. The term “Broker” is defined in Section 3(a)(4) of Securities Exchange Act of 1934 as “any person engaged in the business of effecting transactions in securities for the account of others.” The Settlement Order alleged that Blackstreet itself performed brokerage services with respect to the acquisition and disposition of portfolio companies held by the Blackstreet funds, which included soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing, and executing the transactions themselves, some of which involved the purchase or sale of securities. The respective limited partnership agreements of the Blackstreet funds expressly permitted Blackstreet to charge transaction or brokerage fees, and according to the Settlement Order, Blackstreet received at least $1.87 million in transaction-based compensation in connection with these services.
In the press release accompanying the Settlement Order, Andrew J. Ceresney, Director of the SEC’s Division of Enforcement was quoted as saying “[t]he 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.”
Previously, David W. Blass, formerly Chief Counsel of the SEC’s Division of Trading and Markets, openly questioned whether transaction fees charged by a private fund manager to a portfolio company “in connection with the acquisition or disposition (including an initial public offering) of a portfolio company or a recapitalization of the portfolio company . . . for ‘investment banking activity,’ including negotiating transactions, identifying and soliciting purchasers or sellers of the securities of the company, or structuring transactions” should require the fund manager to register as a broker-dealer.
Blass further stated that “[t]o 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.” However, the Settlement Order does not address whether Blackstreet offset the transaction fees at issue against advisory fees charged to the Blackstreet funds.
On June 7, 2016, the Wall Street Journal reported on public comments offered that same day by Robert B. Baker, Assistant Regional Director of the SEC Division of Enforcement’s Asset Management Unit at the agency’s Boston Regional Office during the SuperReturn U.S. conference in Boston. According to the Wall Street Journal, Mr. Baker described the action against Blackstreet as being “the first case of a private-equity adviser violating section 15(a) of the [Securities Exchange Act of 1934] for acting as a broker and failing to register as a broker.” Mr. Baker cautioned that “[a]dvisers should be carefully considering whether their conduct violates this rule” and further that “[a]ny private-equity adviser that doesn’t have a broker-dealer registration and is earning transaction fees—I’m not saying that’s a violation—but it creates a question.”
Based on this finding, private equity fund managers should examine their own activities and consider whether the nature of services and compensation related to portfolio company transactions gives rise to an obligation to register as a “broker.”
 Speech, A Few Observations in the Private Fund Space, David W. Blass, Chief Counsel, SEC Division of Trading and Markets (Apr. 5, 2013), available at https://www.sec.gov/News/Speech/Detail/Speech/1365171515178.
 On February 4, 2014, Mr. Blass authored a revised no-action letter on behalf of the SEC’s Division of Trading and Markets which allowed relief from the Exchange Act’s broker registration requirements for persons and entities meeting the criteria for being classified as an “M&A Broker” and engaged in certain types of transactions. Generally, an “M&A Broker” for purposes of the no action letter is a person engaged in the business of effecting securities transactions solely in connection with the transfer of ownership and control of a privately-held company through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the company, to a buyer that will actively operate the company or the business conducted with the assets of the company. The relief, however, is contingent upon a number of transaction-specific conditions, including prohibitions against the M&A Broker and its affiliates having custody or control of funds or securities in connection with the transaction, having the ability to bind the parties to the transaction, and providing financing for the transaction. Accordingly, the no-action relief may be of limited use to many private equity firms engaged in these activities and it would appear that the conduct engaged in by Blackstreet was not in compliance with the parameters of this no-action relief.