Broker Dealer Private Fund

It was four years ago that David Blass mentioned that the SEC was taking a closer look at broker-dealer requirements for private fund managers in two contexts: selling interests in the funds and earning fees from the fund for capital transactions.

Part of the problem is that the safe-harbors for selling your fund interests is much narrower than people expect:

  • the person limits the offering and selling of the issuer’s securities only to broker-dealers and other specified types of financial institutions; or
  • 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.

Mr. Blass indicated that the SEC might consider granting a new exemption for private funds. (Of course that is a new regulation and presumably, the SEC would want to revoke two other regulations before making a new one.)

A recent case before the SEC touched on this area. Gregory Smith provided insurance and retirement planning services. At one point he was a registered representative associated with a broker dealer, but was not when he started selling interests in Rampart Fund. Rampart was a private fund selling notes to fund a mezzanine debt program.

Mr. Smith sold $3.75 million worth of notes to 31 investors and received transaction based compensation.  His activities were outside of any of the three safe harbors.

The SEC barred him from the securities industry, and required disgorgement of the compensation for failing to register as a broker-dealer while selling private fund interests.

Of course this case feels different than in-house personnel selling private fund interests. I’m not sure the exemptions treat it differently. I believe many firms look to the “perform substantial duties for the issuer other than in connection with transactions in securities” safe harbor. For dedicated sales personnel, that argument may fall flat.

I suspect what put Mr. Smith in the cross-hairs of the SEC is that Rampart turned out to be a fraud. Mr. Smith raised almost half of the capital that ended up going to Rampart.