There’s a compelling argument that for private equity firms, the costs of SEC registration outweigh the supposed investor protection benefits. Does an industry that’s never given rise to any widespread fraud concerns really need to be spending six-figure-sums every year on legal advisors, compliance staff and other related registration expenses?
Although Congress rejected this argument when it pushed private equity firms under the SEC’s aegis as part of the Dodd-Frank financial reform bill, the House of Representatives is now apparently trying to rectify the situation: last week, it passed a bill that would exempt private equity firms from SEC registration.
This move has been widely praised by the industry. Unfortunately, it's likely to be futile.
For starters, the White House has already promised to veto the bill – and to overcome this veto, the Republican-sponsored bill would need minimum two-thirds approval in the Democrat-controlled Senate, which is never going to happen.
But even if this bill did make it through a future Congress (one under Republican control, say), it still seems unlikely that anything would change much in practice.
That’s because most of the heavy lifting has already been done. The (expensive) preparations required to pass an SEC inspection have, in most cases, already been made – disaster recovery plans have been drawn up, codes of ethics tweaked, compliance officers appointed, Form ADV reporting systems implemented, custody rules examined, and so on.
Nonetheless, surely fund managers would rather avoid all the hassle that comes with a surprise visit from inquisitive SEC inspectors (who often don’t seem to understand the private equity model)? And with no registration requirement, compliance teams could be downsized over time, trimming the firm's cost base.
That may be true for some managers who have failed to get their house in order. But our bet is that most GPs wouldn’t avail themselves of this chance even if it was offered to them. After all, if you’ve already invested substantial amounts of time and resource implementing an airtight compliance program, it would be odd to pass up the opportunity to show it off. That could tarnish the firm’s reputation and prompt some awkward questions from LPs.
What's more, many of the industry’s biggest firms – who typically act as pace-setters for best practice – were already registered with the SEC long before Dodd-Frank was signed in 2010. It’s not unreasonable to assume that other firms lower down the size scale would have followed suit over time anyway, especially in today’s current fundraising climate; LPs now have a stronger voice than they have in the past, and for the most part, they consider SEC oversight to be a good thing.
In our view, the real problem here is that the SEC is trying to enforce blanket rules on the entire investment advisor community (custody requirements being a prime example of where tweaking is needed for private equity funds in particular). So rather than worrying about a repeal that’s unlikely to happen and may have limited impact anyway, the industry should focus its lobbying efforts on fighting for a more tailored (somewhat lighter-touch) approach to private equity registration. That’s a battle worth winning.