Executive decision

Less than five days after many GPs welcomed a government proposal that will rely heavily on private capital to purchase up to $1 trillion in toxic assets, US Treasury Secretary Timothy Geithner followed on 26 March with a dose of bitter medicine, outlining for the House Financial Services Committee a set of guidelines that would substantially heighten government oversight of private equity and hedge funds.

Under the proposal, private investment funds with assets under management over a certain threshold would be required to register with the Securities and Exchange Commission, including reporting any information “necessary to assess whether the fund or fund family is so large or highly leveraged that it poses a threat to financial stability”. Such information would include names of investors, trading partners and details as to how much firms borrow to leverage investments.

This data would be shared by the SEC with a new “systemic risk regulator” who would determine whether a firm's failure would pose a risk to the economy and thus allow the government to seize control, as was the case when the government decided to intervene in saving AIG from bankruptcy last September. Although Geithner hasn't yet provided details as to the new proposed regulatory body, it would have the power to impose stricter capital requirements on firms deemed “at risk”.

“There are no reliable, comprehensive data available to assess whether such funds individually or collectively pose a threat to financial stability,” he said. “In the wake of the Madoff episode it is clear that, in order to protect investors, we must close gaps and weaknesses in regulation of investment advisors and the funds they manage.”

However, David Lerner, a partner at law firm Morrison Cohen, said Geithner's use of Bernie Madoff's $50 billion Ponzi scheme to justify regulating private equity funds is disingenuous. “One, Bernie Madoff wasn't a private pool of capital, and two, he was regulated,” Lerner said. “The fact was, he was a thief. Those two things have a lot more to do with what happened than the fact that private pools of capital are largely unregulated. No one has ever said that a private equity fund manager has had anything to do with what happened in 2008.”

Following Geithner's speech, Washington, DC-based lobbying group the Private Equity Council released a statement saying that it would seek to ensure that any new legislation does not impose undue burdens on the industry.

Even before Geither's proposal, the issue of increased SEC oversight had been brought up in the Senate, with the introduction in February of a bill that would require private funds with $50 million or more in assets to register with the SEC. But while the managing partner of one large firm said he didn't expect the new proposals to be too burdensome, Lerner says if Geithner's assets-under-management threshold ends up falling significantly under $50 million, smaller firms may not be able to handle the cost as easily.

“We don't think that any fund with assets under management of under $50 million can afford to register, the costs are just too high,” Lerner said. “You need at least two additional people on top of your other infrastructure just to manage regulatory compliance issues. Under $50 million, forget it, they'll simply have to shut down.”

The Treasury's reforms still have to win the approval of powerful Congressional members such as New York Senator Chuck Schumer, whose Wall Street constituents include many private equity players. However, with the regulatory tide showing no sign of receding, more GPs will likely recognise that, as Carlyle Chief David Rubenstein said during the recent PEI Emerging Markets Forum, “additional regulation is inevitable”.