The SEC’s kryptonite

Could the threat of a lawsuit save US fund managers from new vexatious regulations?

Bittersweet news for US fund managers this week as the US Securities and Exchange Commission pushes through new reporting rules designed to help regulators monitor systematic risk.   

GPs must now file a new Form PF (short for “Private Fund”) with the SEC, but the rule was dialled back notably from original proposals floated in January.

The form will be held by regulators on a “confidential basis”, used only by agencies to sniff out systematic risk.

The SEC was right to water down the rule’s original language. Buyout firms are largely isolated from most other financial market activity and their failures in only the most extreme of cases would cascade into wider systemic risk – a point made strenuously by industry lobbyists. The SEC in its own way acknowledged this much by increasing the threshold at which firms must submit detailed reporting, exempting firms managing less than $150 million from supervision, and allowing more lead time for GPs to collect portfolio company financial statements for reporting purposes.  

Or, maybe, might argue a cynic, the SEC didn’t feel confident the original proposals would stand up in court. The SEC is required by law to weigh the economic costs and benefits of its rules. Stakeholders in turn have the power to challenge the SEC’s judgement in court. 

Or, maybe, might argue a cynic, the SEC didn’t feel confident the original proposals would stand up in court

Darrell Issa, Republican chair of the House Oversight and Government Reform Committee, suggested the original proposals wouldn’t survive a court challenge last September, saying in a letter to the SEC he was concerned Form PF “will impose a heavy compliance burden on investment advisors” that will ultimately “harm economic growth”. 

Other stakeholders, including letters from the Alternative Investment Management Association and the Private Equity Growth Capital Council, raised similar arguments that the original proposals were unjustified in their scope. 

Their words likely resonated with regulators – just three months ago a US Court of Appeals struck down an SEC rule expanding shareholders rights, ruling the agency “inconsistently and opportunistically framed the costs and benefits” of the initiative and failed to adequately respond to problems raised by stakeholders. The case, which was cited by Issa as an example of the agency’s capacity to overreach, wasn’t challenged by the agency. Our hypothetical cynic might point out a time-strapped SEC is less capable of doing so. The agency’s responsibility under Dodd-Frank alone means crafting over 240 new rules and conducting nearly 70 studies within a short timeframe. 

A call put into Issa’s office asking if he was now satisfied with the revised rule was not returned by press time. However an industry source said it was unlikely any legal challenges will now be made as the Form PF concessions “were more than what many were expecting out of the SEC”.

As such, it seems the SEC might take a more cautious approach in its rulemaking going forward. Important to private equity managers will be upcoming details on their requirements as registered investment advisors come this March. Should the SEC overreach in this area as well, stakeholders may be tempted to hint at possible legal action in their fight to readjust regulations they feel too onerous.