Washington, D.C.- Last week, the private equity industry scored its first victory in its campaign to roll back the Securities and Exchange Commission’s regulatory oversight of private equity fund advisers. Under the guise of a simple ‘technical correction’, the House of Representatives passed H.R. 37, the Promoting Job Creation and Reducing Small Business Burdens Act. Title IV of that Act will likely exempt some advisers to large private equity firms from registering with the SEC as broker-dealers and eliminate the investor protections such registration provides.
The Dodd-Frank Act, passed in the wake of the financial crisis, subjects the private equity industry to broad regulatory oversight for the first time in its history. SEC examinations have found that in half the cases it reviewed PE fund advisers had evaded their fiduciary responsibility to investors or violated securities law requiring registration as a broker-dealer. An exemption from registering as broker-dealers in connection with the merger and acquisition activities of their portfolio companies – a legal requirement that predates Dodd-Frank and has mostly been ignored by PE firms and fund advisers – is high on the industry’s wish list. H.R. 37 provides partial relief from this requirement. The industry hopes that this will set the stage for further roll backs in regulatory oversight. Ultimately, the PE industry wants to do away with the Dodd-Frank requirement that general partners of larger PE funds must register with the SEC.
A new report by Senior Economist Eileen Appelbaum of the Center for Economic and Policy Research (CEPR) looks at recent SEC investigations of private equity funds and demonstrates why it remains important to continue to regulate the industry. The report, “Private Equity and the SEC after Dodd-Frank,” reviews the widespread practices in the industry, uncovered by the SEC, that have unfairly enriched some private equity firms at the expense of pension funds and other investors in their funds.
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“For over 30 years, advisers to large PE funds enjoyed an exemption from the long-standing requirement that investment advisers must register with the SEC,” said Appelbaum. “This allowed them to avoid regulatory oversight and the enforcement of securities law. Dodd-Frank changed this by requiring advisers to private equity funds to register with the SEC.”
The new reporting requirements have enabled the SEC to identify serious abuses by some fund advisers. Appelbaum discusses the implications of these misdeeds for the limited partners who are the investors in these funds. Improper behavior by general partners includes manipulating the value of companies in their funds’ portfolios, waiving their fiduciary responsibility to investors (including pension funds), misallocating PE firm expenses and inappropriately charging them to investors, failing to share income from monitoring fees charged to portfolio companies with their limited partners, and acting as broker-dealers and collecting transactions fees from portfolio companies without registering as broker-dealers as required by law.
As the report shows, enforcement to date has been weak. The SEC’s revelations have caused a small number of PE firms to voluntarily rein in their funds’ most egregious practices, but most firms have not attempted to make amends for past violations or stop such practices in the new funds they sponsor. The industry would like to water down the regulatory and oversight powers of the SEC and wants to avoid prosecution for past violations of securities law. Dodd- Frank has just begun to expose the billions of dollars in ill-gotten gains for the partners or top executives at these PE firms.
The overly broad wording in Title IV of H.R. 37 is widely seen as a victory for the private equity industry. But, as this report makes clear, it is a step in the wrong direction for the American public.