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Regulators may target leverage

The private equity industry could yet be surprised by government efforts to oversee finance, says a legal expert

Most private equity firms believe that they will be subject to some amount of additional scrutiny in light of all manner of excess and deception in the investment funds market that has come to light in recent months. But just what that scrutiny might look like, and how much it would affect the day-to-day operations of the firm, is less certain. At least one legal expert has pointed to the possibility of government oversight of leverage.

The oft-mentioned regulatory possibility is that all hedge funds and all private equity funds will be required to register as investment advisors. A bill already exists in the US Senate to this effect. General partners with more than 14 “clients”, or funds, under management at once are already required to do so, so the process is at least somewhat of a known quantity for private equity firms.

But if that's all that private equity firms have to contend with, they'll be “very, very lucky”, Washington DC-based Akin Gump Strauss Hauer & Feld partner Prakash Mehta said during a panel discussion in the recent PEI Media CFOs and COOs Forum in New York. “I think we're probably in for a lot more in the way of new requirements, new regulations, a new and improved investment advisor statute, than some of us may now be expecting,” Mehta told the audience.

Another possible outcome is that bank holding companies will no longer be allowed to have proprietary trading or private equity investing activity within the firm, Mehta said.

Independent private equity firms, meanwhile, may end up being regulated not just by the Securities and Exchange Commission, but by the Federal Reserve, because they employ leverage in their investment activities. “If you look at some of what has caused the financial crisis, I agree that private equity hasn't been at the center of the storm in the way that the banks and the hedge funds have,” Mehta said. “But nonetheless there's a lot of money under management in this room and in rooms like it across the country, and that money is being deployed not just directly but often-times with the use of leverage, and there is essentially no one in our system who is right now monitoring overall and on a systemic basis how much leverage is being deployed.”

Senate votes to cap executive pay
The US Senate has approved an amendment that would limit executive compensation to $500,000 for financial institutions that received funds from the Treasury Department's Troubled Asset Relief Program (TARP). Unlike previously announced limits proposed by President Barack Obama, which would impose stricter rules on expenses related to entertainment, holiday parties, conferences and the use of corporate jets, the Senate amendment would prohibit firms receiving TARP funds from paying bonuses to their top-25 highest paid employees. The Treasury Department could also increase the number of employees who would be prohibited. The institutions that have sought out TARP relief so far include Citigroup, Morgan Stanley, AIG, Bank of America and JPMorgan Chase & Co. The pay limit would not apply retroactively but instead on future TARP transactions, which may dissuade some banks from seeking out federal assistance.

Rockwood hires IR exec
Rockwood Capital has appointed Sharon Miller as managing director to help lead its investor relations team. Miller was previously global managing director at Trammell Crow's global services group and has worked with Hart Advisers, JP Morgan Investment Management and JW O'Connor & Company. Ed Kavounas, Rockwood chief executive officer, said in a statement the appointment was important “at this time in the real estate cycle”. Private equity real estate firms are actively working with their limited partners as they struggle against the so-called denominator effect, declining distributions from existing investments and the fear of capital call defaults. Kavounas added it was important to have a “strong understanding of [LPs'] needs and the challenges they face in this environment”. Last week, White Plains, New York-based Rockwood promoted David Streicher to partner and Jennifer Levy to chief financial officer.

Canadian group criticises lack of VC investment
Canada's Venture Capital and Private Equity Association (CVCA), which represents more than 1,500 private equity firms in the country, has criticised the recent federal budget for not addressing a shortage of venture capital financing in the country. Venture capital investment in Canada fell 40 percent in the fourth quarter of 2008 versus the same period a year before, while the CVCA says the country's tax system – notably Section 116 – has deterred investment by forcing foreign venture capital firms to report investments made in Canada to the tax department. In the past the CVCA has recommended setting up third-party managed fund of funds to help fuel private sector growth and increasing government procurements to encourage investment in venture capital funds. The group also called for incentives for large Canadian corporations to invest in venture capital funds. “The government has missed an important opportunity to ensure a vibrant venture capital industry and investment in innovation at a time when our country needs it the most,” CVCA president Gregory Smith said.

“Bad bank” plan targets $1tn in toxic real estate assets
Real estate executives welcomed plans by the Obama administration to create a $1 trillion public-private investment fund aimed at ridding financial institutions of their toxic real estate-related assets – as well as expanding help for commercial mortgage lenders. US Treasury Secretary Timothy Geithner said the investment fund – dubbed the “bad bank” fund – would start with an initial capacity of $500 billion, but would expand up to $1 trillion depending on the success of the programme. He said it would use “government capital and government financing to leverage private capital to help get private markets working again”. Although the structure of the fund has yet to be finalised, Geithner said private firms and asset managers would help value the “real estate-related assets that are at the center of this crisis”. US lobby group the Real Estate Roundtable, welcomed the measures, saying they were a “positive step forward” for the commercial property industry.

CEI comes out against hedge, private equity regulation
The Competitive Enterprise Institute has released a paper stressing the benefits of the private equity and hedge fund industries for the public and urging US regulators not to burden the industries with “cumbersome regulations”. These two industries benefit more than just their investors, the think tank says, by building wealth in distressed and start-up companies, and forcing public companies to create more wealth for shareholders through streamlining. The paper also points out that both industries provide liquidity and have reduced risks of disruption to capital markets. “Private equity firms have helped to ease the credit crunch by helping to recapitalise commercial banks and stepping in to fill the void of investment banks in financing new business growth. Hedge funds were ahead of the curve in short-selling subprime securities – thereby sending out valuable market information about the risks of those instruments.” The paper recommends that Congress reject attempts to make hedge funds and private equity funds register with the Securities and Exchange Commission, stop the SEC from raising the minimum requirements for hedge fund and private equity investors and revise the Investment Company Act of 1940 to allow mutual funds and exchange-traded funds to pursue the same strategies as hedge and private equity funds, including short-selling.