Private-equity-fund advisers balk at new oversight rules

Reform legislation requires the vehicles to register with SEC

Jul 25, 2010 @ 12:01 am

By Mark Schoeff Jr.

Financial advisers to some private-equity funds fear that efforts to reduce systemic risk in the financial markets, a key theme of the massive reform bill signed into law last week, are unfairly targeting them.

In a congressional hearing last week, Rep. Carolyn Maloney, D-N.Y., questioned a provision of the measure that will force advisers to private-equity funds larger than $150 million to register with the Securities and Exchange Commission.

The new law will eliminate the so-called 15-client rule, which allowed private-equity and hedge funds with relatively few clients — but substantial assets under management — to avoid SEC oversight. Advisers sometimes recommend private-equity placements for high-net-worth clients.

Ms. Maloney, who represents Manhattan's Upper East Side, said that she has heard from many private-equity advisers who maintain that they couldn't possibly pose a high risk to the financial system, be-cause their portfolios don't contain derivatives and aren't heavily leveraged.

“They're concerned because they feel that they're not a threat in any way,” she said last Tuesday as she left a hearing of the House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises.

“They claim that being registered will cost them hundreds of thousands of dollars,” Ms. Maloney told SEC Chairman Mary Schapiro at the hearing. Ms. Maloney suggested that the SEC establish two levels of registration — one for high-risk funds and one for those that aren't leveraged or engaged in risky trading.


Ms. Schapiro indicated that the SEC doesn't want to create registration loopholes but that it also “will be very sensitive” to the concerns of smaller firms as it fleshes out the new rule. The law gives the SEC discretion to set different levels of information requirements based on risk.

“She seemed open to consideration, which I think is a good answer,” Ms. Maloney said.

The new law requires that private-fund advisers maintain re-cords pertaining to the amount of assets under management, use of leverage, counterparty exposure, trading and investment positions, valuation policies and practices, types of assets held, side letters and trading practices.

These records wouldn't necessarily have to be filed with the SEC but would be subject to inspection by the agency. Private-fund advisers also will have to establish compliance programs, adopt a code of ethics and appoint a compliance officer.

“Ultimately, the changes effected by the bill are likely to materially increase the costs of compliance and may cause certain investment advisers, such as non-U.S. advisers, to decline to manage the assets of U.S. investors,” according to an analysis of the financial-reform bill by the law firm Davis Polk & Wardwell.

The effect on hedge funds may not be great. Larger ones have been registering with the SEC for a number of years, in part to make themselves more attractive to institutional clients.

The story is different for private equity.

“Many requirements are not consistent with what they're doing,” said Elizabeth Fries, a partner at Goodwin Procter LLP. “Compliance for private equity is a square peg in a round hole.”

Hedge fund and private-equity groups haven't resisted the new registration requirements.

Steve Hinkson, director of communications for the Managed Funds Association, said that the hedge fund group has backed SEC registration for advisers to all private-capital pools.

“This and other areas of regulatory reform will significantly in-crease oversight and regulation of hedge funds and hedge fund advisers, and will require industry participants to allocate significant time and resources, at a meaningful cost, to legal and regulatory compliance,” he said.

The Private Equity Council has backed registration for larger private-equity firms in order to restore confidence in the financial system, said Robert Stewart, vice president of public affairs.


But he argues that the structure of the firms prevents them from instigating a market meltdown. They aren't interconnected, their failure doesn't prompt capital calls, and they comprise long-term investments, Mr. Stewart said.

“We do not believe that any private-equity firm of any size poses systemic risk,” he said.

The council estimates that there are 640 private-equity pools with more than $150 million in assets under management.

The total size of private funds and their influence, however, tends to be opaque. The SEC points to adviser registration as an important tool to enhance its ability to monitor markets.

“There's a lot we would like to know about hedge funds, and their trading and other activity,” Ms. Schapiro told reporters after the July 20 congressional hearing.

The new registration requirements will mean that a fund with billions of dollars under management but fewer than 15 clients will no longer be able to skirt SEC oversight.

“On a macro level, it will have a great effect,” said Scott Moss, a partner at Lowenstein Sandler PC. “You are picking up that larger manager.”

It is unclear whether the SEC has the capacity for the additional responsibility.

Another part of the reform legislation raises the threshold for SEC oversight of investment advisers from $25 million in assets under management to $100 million.

States would pick up the approximately 4,000 advisers who fall into that category.

“That is designed to help render the SEC's workload more manageable, given all the hedge fund managers that will be wandering into town,” said Laura Corsell, a partner at Montgomery McCracken Walker & Rhoads LLP.

Ms. Schapiro said that she can't yet determine how much busier the SEC will be in its monitoring activity.

“It's really kind of in flux exactly how much work we'll have offset by how much work we won't have,” she said.

E-mail Mark Schoeff Jr. at


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