The Financial CHOICE Act of 2017, which was passed by the House of Representatives last week, would deregulate private equity in the U.S., among other things, easing the load for all but the smallest U.S. private equity firms.
Among the key changes for private equity managers, the act would eliminate the requirement that private equity firms register with, and be regulated and examined by the Securities and Exchange Commission.
For investors, SEC oversight has helped to dramatically increase transparency, expanding the amount and quality of information limited partners can obtain from their private equity managers.
Should private equity firms no longer be subject to such regulation, some institutional investors fear they could return to a world in which they invested in private equity based on hope and a good story, with little clarity into whether they were being treated fairly by general partners.
Investors are closely watching the bill's progress.
Officials at the $322.3 billion California Public Employees' Retirement System, Sacramento, are closely monitoring the bill, spokeswoman Megan White said in an email.
Immediately after the House passed the bill — which is expected to stall, as there is no vote scheduled in the Senate — investors and representative groups voiced their opposition.
The board of the $206.5 billion California State Teachers' Retirement System, West Sacramento, voted June 8 to oppose the CHOICE Act. The name of the legislation stands for Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs.
“The Financial CHOICE Act is shrouded in rhetoric about fixing the United States economy and lifting the regulatory burden on our financial institutions,” CalSTRS CEO Jack Ehnes said in a written statement. ”On the contrary, this bill actually ... decimates the Securities and Exchange Commission's ability to protect investors.”
The bill would roll back protections in the Dodd-Frank Wall Street Reform and Consumer Protection Act that required transparency in the form of registration and reporting by private equity firms, a staff report to the CalSTRS board noted.
The bill “could potentially expose long-term investors like CalSTRS to greater financial risk,” the staff report stated.
Ken Bertsch, executive director of the Washington-based Council of Institutional Investors, said in a statement the organization is “deeply disappointed” by the passage of the CHOICE Act.
The Institutional Limited Partners Association, Washington, also expressed concern: “We are disappointed that the House of Representatives passed legislation that eliminates a regulatory structure that has been extremely beneficial to fostering transparency, disclosure and sound governance within the private equity industry,” said Peter Freire, CEO of the ILPA, in a written statement.
A recent ILPA survey of its members revealed that 92% support SEC registration and oversight of the private equity industry, said Chris Hayes, the association's director of industry affairs.
“Since 2012, we've seen improved disclosure of fees and expenses,” Mr. Hayes said.
Regulations also have helped to ensure compliance with limited partnership agreements as well as a “better culture of compliance,” he said in an interview before the June 8 House vote.
“We've seen a lot of positive benefits and increased alignment between general partners and limited partners,” Mr. Hayes said.
Private equity firms contacted for this story — including The Blackstone Group LP, The Carlyle Group and KKR & Co. LP — declined to comment on the impact of the bill's passage in the House.
But their industry group — the American Investment Council, Washington — said in a statement “The AIC has consistently supported legislation to improve the regulatory environment for private equity investment advisers, and the Financial CHOICE Act moves in the right direction on several fronts.
“Overly burdensome, costly, ill-tailored, and unnecessary regulatory hurdles should be eliminated, or at a minimum scaled back, whenever possible,” the statement continued. “The Financial CHOICE Act would improve the regulatory environment while maintaining SEC oversight.”
Bruce Runciman, executive director of AxiomSL, a New York firm that offers consulting, and regulatory and risk reporting systems for private equity managers and investment bankers, said if Congress eases private equity regulations, managers “will have a little cheer for a moment, but it will not change the big picture.”
Publicly traded private equity firms will still have to be regulated by the SEC and non-traded private equity firms will still need to file certain information with federal regulators.
Also, private equity firms raising money abroad already comply with far more stringent regulations than those in the U.S.
Investors would still push
Should efforts to ease private equity regulation be successful, investors would still push their general partners to act as if they were regulated, said Bill Mulligan, San Francisco-based president of Cordium, a regulatory compliance firm for the financial and banking industries. Some of his firm's clients that are currently exempt from regulation have the same information reporting and processes as they would have if they had been regulated because it is required by investors, Mr. Mulligan noted.
If Congress votes to deregulate the private equity industry, there will be pushback from private equity firms' investor base, Mr. Mulligan said.
David Bailey, co-founder, group head of marketing and communications, in the London office of Augentius Group Ltd., a service provider for private equity and real estate managers, said regulatory oversight of private equity firms in the U.S. has been good for the industry overall.
“The U.S. had been an anomaly in not having regulatory oversight,” Mr. Bailey said. “Bearing in mind what the SEC has found, it has probably been healthy for the industry that the SEC has been involved.”
Since 2012, the SEC has prosecuted 11 enforcement actions against private equity players, including Fenway Partners LLC and the Blackstone Group. But SEC Chairman Jay Clayton has signaled in public statements that he is focusing less on enforcement than on market reform.
“There is widespread speculation among those in the private equity industry that the next iteration of the SEC will be friendlier to the private equity industry than the past administration,” said David Fann, New York-based president and CEO of private equity consulting firm TorreyCove Capital Partners LLC. “It's not just the regulations, but also the interpretation and enforcement of the laws and regulations that are at play.”
The SEC's actions were not “out of kilter” with many other countries, Mr. Bailey said. In the U.K., private equity managers are held to a stringent regulatory regime in which regulators inquire into the manager's track record, previous experience, back-office technology and the number of people the manager expects to employ, among other factors, he said.
Guernsey, Luxembourg, the European Union and Singapore all have more stringent regulatory regimes for private equity than the U.S., Mr. Bailey said. China is currently considering strengthening its regulatory oversight of private equity, he added.
“This (bill) could be good for very large U.S. managers, but it could have a negative effect on smaller U.S. managers if investors are not given the regulatory assurances,” Mr. Bailey said.
the only move afoot to lessen regulation for the private equity industry.
The National Venture Capital Association is trying to get growth equity private equity firms exempted from SEC oversight. They would be covered by the CHOICE Act if it were to become law. Venture capital firms already are exempt from SEC oversight.
Another bill — the Investment Advisor Modernization Act — didn't pass Congress in the last legislative session but is expected to be filed with a new sponsor this session. The 2016 version of the bill had provisions that would have eliminated the requirement that private equity managers file Form ADV 2A, a summary of fees, expenses and carried interest; investment strategies; risk of loss; and other financial information. It also would have exempted friends and family co-investment vehicles from the annual fund audit and surprise examination requirement.
While not taking a position on the CHOICE Act, NVCA executives are pushing the Trump administration and others to exempt growth equity private equity firms from registration as investment advisers.
“Forcing growth equity firms to become registered investment advisers is a huge burden with little public policy benefit,” said Ben Veghte, NVCA spokesman, in a written statement in response to questions. “These late-stage venture capital firms are forced to spend significant time and financial resources complying with a regulatory regime that was never intended for their business model.”
The NVCA defines growth equity firms as those that among other things tend to have investments with little or no leverage, returns obtained through company growth and usually no additional financing rounds expected until exit. Such private equity firms also invest in companies that are often founder-owned and/or managed.
“We are engaged in ongoing conversations with the Hill, the Trump administration and regulators on how we can right-size the RIA regulatory regime by exempting critical capital formation activities for emerging growth companies from triggering the onerous registration requirement,” Mr. Veghte said.
This article originally appeared in the June 12, 2017 print issue as, "Investors leery of easing private equity regs".