Are Your Private Fund Employees Licensed?

compliance and licensing

I think many real estate fund managers and private equity fund managers may be concerned that there are some additional licensing requirements now that they are registered with the Securities and Exchange Commission as an investment adviser. If you didn’t require licensing with your current business model before Dodd-Frank you likely don’t require licensing post-Dodd Frank. Obviously there are many business models and internal compensation structures and each changes the analysis. Of course, a fund manager may have missed the licensing requirement in the first place.

David W. Blass Chief Counsel, Division of Trading and Markets U.S. Securities and Exchange Commission mentioned in a speech earlier this month that the SEC is focusing on this issue. Absent an available exemption or other relief, a person engaged in the business of effecting transactions in securities for the account of others must generally register under Section 15(a) of the Exchange Act as a broker.

A firm needs to be very focused on this issue if it is paying compensation to its employees that depends on the outcome or size of the securities transaction:  transaction-based compensation. The SEC views the receipt of transaction-based compensation is a hallmark of being a broker.

There is an “issuer exemption” in Exchange Act Rule 3a4-1 that provides a non-exclusive safe harbor under which associated persons of certain issuers can participate in the sale of an issuer’s securities in certain limited circumstances without being considered a broker. One key aspect of that rule is that the employee

Is not compensated in connection with his participation by the payment of commissions or other remuneration based either directly or indirectly on transactions in securities. Rule 3a4-1 (a)(3)

Beyond that threshold requirement, there are several other hurdles under the rule.  Blass summarizes those hurdles:

A person must satisfy one of three conditions to claim the issuer exemption from broker-dealer registration:

  • the person limits the offering and selling of the issuer’s securities only to broker-dealers and other specified types of financial institutions;
  • the person performs substantial duties for the issuer other than in connection with transactions in securities, was not a broker-dealer or an associated person of a broker-dealer within the preceding 12 months, and does not participate in selling an offering of securities for any issuer more than once every 12 months; or
  • the person limits activities to delivering written communication by means that do not involve oral solicitation by the associated person of a potential purchaser.

On the bright side, Blass indicates that the he would consider a rule providing a broker-dealer registration exemption written specifically for private fund advisers.