Private equity firms have good reason to be optimistic, as fundraising has reached levels not seen since the years preceding the financial crisis of 2008. Private equity and venture capital funds have raised more than $240 billion in the U.S. and Europe in the first seven months of 2017 alone, according to a report from Pitchbook. Across all global regions, private equity fundraising is expected to crest at a record $561 billion by the end of 2017.
Growth, however, presents its own hurdles — none more critical than compliance. As mid-market private equity firms and their portfolio companies grow and expand their reach, compliance obligations can increase exponentially. Mid-market private equity firms must contend with a seemingly unending string of compliance requirements and information requests from investors, advisors and regulators, at home and abroad.
Without a plan for handling this enhanced compliance burden, firms can lose sight of strategic priorities, quickly lose momentum and even face crippling penalties and sanctions. Staying ahead of such challenges is vitally important for firms that wish to remain competitive. Political changes, too, could offer some relief for U.S. firms — while offering fresh challenges for those on the other side of the Atlantic. This 3-part series offers insight into regulatory rightsizing, regulatory challenges in Europe and compliance challenges.
Part 1: Advocating for rightsized regulations
The heightened regulatory burdens private equity advisors face today can be ascribed largely to the passage of Dodd-Frank in 2010. Today, private equity advisors must register with and submit to examinations from the SEC in a manner outlined by the Investment Advisors Act of 1940 — an act that was originally aimed at retail rather than institutional investors.
Modern private equity advisors must also deal with stringent regulation governing areas such as cybersecurity, valuations, co-investments and fee and expense disclosure. With the election of the new U.S. presidential administration, there was widespread feeling that this regulatory posture would be significantly relaxed. This shift has yet to occur, as the SEC has been quite active in terms of private equity examinations and audits in 2017.
That could change with the adoption of the Financial CHOICE Act, which was introduced into the U.S. Congress in an attempt to roll back regulations associated with Dodd-Frank. The act, which passed the House of Representatives in June 2017, would deregulate the U.S. private equity industry and significantly reduce oversight for all but the smallest firms. Among the most impactful changes proposed by the act would be the elimination of the requirement that private equity firms register with and submit to regulations and examinations from the SEC.
Additionally, the act would limit the SEC’s use of administrative proceedings, give respondents stronger tools to deploy during investigations and remove financial incentives for whistleblowers implicated in wrongdoing while also increasing penalties for violations.
While some observers believe the act would help rein in oversight that has gone too far in the wake of Dodd-Frank, others have raised concerns that these changes are a bridge too far, and would remove needed protections against behavior that could spark another financial crisis.
Because the Financial CHOICE Act passed on a straight party line vote, its political future remains uncertain. Should it muster enough support to pass the U.S. Senate, significant modifications will likely be made. The Cypress Group and other advocacy organizations have been working diligently to raise awareness in Congress of issues facing mid-market private equity firms. Ultimately, these advocates hope to convince legislators to pass a law that right-sizes private equity regulation so that it better matches the investment model with which today’s firms work.
Although observers are cautiously optimistic about seeing some progress toward regulatory rightsizing, these changes are not likely to occur earlier than the first or second quarter of 2018.
Ian Bone is the Senior Manager of Strategy & Innovation at CT Corporation, a legal services & compliance provider and recipient of the 2017 Deal Partner of the Year award from ACG NY in recognition of the 13,000 merger filings and 1.2M due diligence inquiries they handled the previous year. He is a member of the ACG New York Board as well as the Programming Committee. A finalist for 2017 Thought Leader of the Year from AM&AA and an ACG New York member since 2014, Mr. Bone has also continued in his role as Chair of the Champions Awards Gala and Vice Chair of the ACG University Committee.