Decision time for the Financial Choice Act

The bill that could eliminate the Volcker rule and many other Dodd-Frank provisions has started its journey through Congress.

The House Financial Services Committee has held a hearing on the revised Financial Choice Act, originally penned in 2016 by Republican Jeb Hensarling, and the bill is expected to reach the House floor within weeks.

It has generated hype on both sides of the political divide. Republicans, keen to loosen financial regulation, say it will lift the stagnant economy, while Democrats are concerned it will result in the re-emergence of “risky and predatory Wall Street practices” and have vowed to fight it.

Beyond the elimination of the Volcker rule, which states banks can only hold 3 percent of Tier 1 capital in private investments, the FCA contains provisions that will affect private fund managers and their operations.

Registration exemption

The act exempts private equity fund managers from the registration and reporting obligations of the Investment Advisors Act. This would likely also be true of private real estate fund managers, although there is no definition of private equity fund in the draft document. The Securities and Exchange Commission would be required to confirm the definition of a ‘private equity fund’ within six months of the law’s entry into force. The Institutional Limited Partners Association opposes this change, saying registration has enforced transparency and ensured compliance with mandatory reporting procedures.

Accredited investors

The definition of accredited investor will be expanded under the FCA to include licensed brokers and investment advisors. The SEC will also be able to create a regulatory regime for individuals to prove that they have the knowledge, education or job experience to allow them to invest in private assets. The two tests used to establish whether someone is accredited – income and net worth – will remain in place, but the values they must reach to pass the test will be fixed indefinitely. Under Dodd-Frank, the SEC must adjust these figures every four years. Anyone currently considered an accredited investor will continue to be so under the FCA, lawyers at Debevoise said in a client update.

General solicitation
A presentation at a college or university, non-profit, angel investor group, venture forum or trade association will no longer be considered an act of general solicitation under the FCA, so long as the sponsor complies with a number of rules, such as not charging fees beyond administration costs.

Form D

The SEC has for years been mulling changes to Form D introducing strict penalties for firms that start any activity that could be considered general advertising and solicitation before filing Form D. This might have presented a challenge to private fund firms, as it can be unclear what activity is classified as “general advertisement or solicitation.” Under the FCA, these changes would not go ahead.

We do not yet know how far the bill in its current form will progress through the legal system. As we went to press, Hensarling was looking to move to a vote by the Republican-majority Financial Services Committee after one hearing. The Democrats’ position was that they wanted to vote on it as separate bills but have said they would support some of the provisions. What we do know is the FCA could have far-reaching consequences for private fund managers.