Mixed Signals, But Hope, For A Private Adviser Broker-Dealer Exemption

Provisions of the JOBS Act and two recent no-action letters for venture capital advisors initially provide a glimmer of hope that advisors to privately offered funds might not have to register as a broker-dealer when soliciting investors for their funds. A closer examination of the finer details of these materials, however, dashes any such hope, and returns a private fund advisor to the complicated factual analysis of whether it is acting as a "broker" and is therefore required to register as a broker-dealer pursuant to Section 15(a)(1) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Given the serious consequences that follow from acting as a broker-dealer without registering, private fund advisors should carefully assess their conduct and business practices.

Additionally, private fund advisers should be aware of, and strongly consider responding to, an overture by the Chief Counsel in the SEC's Division of Trading and Markets in a recent public speech to evaluate and potentially propose a new exemption from broker-dealer registration requirements specific to private fund advisors.

STATUTORY TEST OF BEING A "BROKER" AND SECTION 15(A) REGISTRATION REQUIREMENT

Section 15(a)(1) of the Exchange Act requires any person that acts as a "broker" or "dealer" of securities to register with the SEC. Section 3(a)(4)(A) of the Exchange Act defines "broker" generally as "any person engaged in the business of effecting transactions in securities for others." (emphasis added). An adviser to a private investment fund potentially acts as a "broker" in connection with the marketing and placement of fund membership interests with investors.

The tests for these two factors are very fact-specific and are often subjectively applied. The SEC staff views one as "engaged in the business" of effecting securities transactions when there is a "regularity of participation" in such transactions.1 Effecting transactions on more than a one-off basis often meets this test. The concept of "effecting securities transactions", similarly, is broadly interpreted to cover participation "at the key points in the chain of distribution" of securities and includes assisting in structuring a transaction, identifying potential purchasers, soliciting transactions (including advertising), and participating in the order taking or order routing process.2 Advisers to private funds are typically involved in identifying potential investors and structuring those investors' investments in the fund. Another key factor, and perhaps the most significant factor, is the presence or absence of transaction-based compensation. The rationale for this factor is that the financial incentive created by a commission or other transaction-based compensation creates a "salesman's stake", pursuant to which the marketer, like a broker, has an interest in the transaction succeeding and the limited partner interests being placed. Rule 3a4-1 under the Exchange Act, informally known as the "Issuer's Exemption", is a non-exclusive safe-harbor technically available to employees of an issuer of securities, such as a private investment fund adviser and its personnel. The Issuer's Exemption, however, is limited to personnel engaged in no more than one offering every twelve months. As a practical matter, since private investment funds offer their securities over a period of time that can last for months or even a year, the Issuer's Exemption provides little regulatory cover.

For all of these reasons, an adviser to a private investment fund must engage in a difficult and comprehensive factual analysis, weighing all activities (e.g. soliciting investors, regularity of participation, etc.) to determine whether broker-dealer registration is required. Although private investment fund advisors and their employees do not typically receive transaction-based compensation in connection...