The Securities and Exchange Commission (SEC) granted a settlement offer
on June 1 concerning violations by a Maryland-based private equity firm
and its principal, Murry Gunty, of Section 15(a) of the U.S. Securities
Exchange Act of 1934. Specifically, the allegations involved the breach
of restrictions on providing unregistered brokerage services in addition
to violations of Sections 206(2) and 206(4) and Rules 206(4)-7 and 206(4)-8
of the U.S. Investment Advisers Act of 1940 concerning fraudulent activity
and material misrepresentation by financial advisers. The settlement resulted
in the adviser disgorging the compensation he received as a result of
his unlawful activity in addition to interest and a civil penalty.
The case, In the Matter of Blackstreet Capital Management, LLC, (SEC Release
No 34-77959), represents the first instance in which the SEC has brought
an action against a registered investment adviser for not formally registering
as a broker, and as a result of their acceptance of capital garnered from
transactions related to services provided to fund portfolio corporations.
Blackstreet gave advice regarding the acquisition and disposition of its
funds’ portfolio organizations, which periodically encompassed buying
and selling securities, soliciting potential business arrangements, selecting
clients, planning financial arrangements, and processing transactions.
The subsequent fees for these services were undeniably lawful and duly
reported in the governing financial reports. However, the adviser collected
more than $1.8 million of transaction-related payments without ever registering
as a broker, thereby breaching the broker-dealer registration mandates
of the Securities Exchange Act of 1934 and prompting the SEC to seek enforcement action.
The settlement potentially foreshadows the SEC taking the position that
in certain situations, transaction fees may not be collected by private
equity funds unless they are registered broker-dealers, despite the fact
that equity funds have historically claimed their services related to
facilitating portfolio company transactions does not involve activities
that would mandate their registering as an official broker.
The Securities Exchange Act of 1934 prohibits a broker to “effect
any transactions in…any security…unless such broker or dealer
is registered,” and defines “broker” as “any person
engaged in the business of effecting transactions in securities for the
account of others.” It follows then that a fund would only be required
to register as a broker-dealer if it “engaged in the business of
effecting a transaction” in securities for a third party. The Securities
Exchange Act, however, is silent as to what constitutes being “engaged
in the business of effecting transactions,” the only guidance within
the industry being SEC press releases, or enforcement actions and federal
court decisions on the matter.
The SEC initially hinted at their impending investigation of unregistered
brokerage activity in an April 2013 speech by David W. Blass, SEC Chief
Counsel of the Division of Trading and Markets. He said his staff was
“putting an increased examination focus on private fund advisers,”
specifically instances in which “the private fund adviser…receive
transaction-based compensation for purported investment banking or other
broker activities…[and] inappropriately claiming to rely on exemptions
to avoid broker-dealer registration.”
Following the SEC’s successful enforcement of unregistered broker
activity against Blackstreet, there is industry-wide speculation as to
whether private equity advisers should cease collecting similar fees or
should instead completely offset them against the management payment.
Current market data trends indicate these fees are routinely being offset,
either in part or in full, against the management compensation afforded
to advisers. As a result of the Blackstreet settlement, investment advisers
could avoid similar potential prosecution by examining any transaction-related
fee agreements to determine if they constitute services requiring broker
Contact Geraci Law Firm at (949) 298-8050 today, or contact
for more information.