US states may soon be granted the power to regulate private equity firms with assets under management of less than $100 million.
The financial services committee of the US House of Representatives recently passed the Investor Protection Act of 2009, which would raise the threshold of assets under management, from $25 million to $100 million, that dictates whether a manager will be regulated at the state or the federal level.
That means that firms with assets under management of $100 million or less will answer to state regulators. The bill will be voted on by the full House of Representatives and then sent to the US Senate for a vote by that chamber of Congress.
Since the passage of the National Securities Markets Improvement Act of 1996, investment advisors with less than $25 million in assets under management had to be regulated by the state in which they were domiciled, while all those with more than $25 million were automatically subject to federal regulation. A manager with offices in multiple states could find itself reporting to several state regulators, which means sifting through myriad rules and regulations for each state. Now, all advisors with less than $100 million must be regulated at the state level.
It's much nicer to have a regulator that understands your business than a regulator that is truly learning on the job.
Generally, when the choice is federal versus state regulation, private equity managers prefer to be regulated at the federal level, said Nathan Greene, a partner at the law firm of Shearman & Sterling. Even with the $25 million threshold, Greene said he has heard of managers asking how to count their assets under management in a way that will bring them over the threshold. Those managers who find themselves newly assigned to state regulators, particularly at the larger end of the AUM range, may not be happy about this development, he said.
There are a number of reasons for the preference. Managers with offices all over the country want to avoid the “patchwork problem” of having to register in and comply with the regulations of several states. The Securities and Exchange Commission is also widely viewed as a more politically independent and predictable regulator than some of its state-level counterparts. The SEC is also fairly knowledgeable about the various alternative asset classes, whereas many state regulators will need to play catch-up.
“It's much nicer to have a regulator that understands your business than a regulator that is truly learning on the job,” Greene says.
When examinations are conducted, the SEC has demonstrated a lack of understanding as to the business of these registrants. An ‘oversight gap’ exists.
Denise Voigt Crawford
However, for some managers with offices in only one state, particularly a state like New York or Connecticut that is fairly savvy in dealing with hedge funds and private equity funds, dealing with local regulators might mean a lighter touch than dealing with the SEC.
The North American Securities Administrator Association (NASAA) sees the move as a much-needed reprieve for the overworked SEC. In testimony before the Committee, NASAA President and Texas Securities Commissioner Denise Voigt Crawford said state regulators are eager to step in and take some of the regulatory burden off of the SEC.
“When examinations are conducted, the SEC has demonstrated a lack of understanding as to the business of these registrants. An ‘oversight gap’ exists,” Crawford testified. “NASAA members are fully prepared and equipped right now to fill this gap by accepting responsibility for the oversight of investment advisors up to $100 million in assets under management.”
The higher threshold would bring around 4,000 new investment advisors under the states’ regulatory authority, said Bob Webster, director of communications for NASAA . It would mean significantly more work for those regulators, but Webster said they are prepared for the burden.
“They’re prepared; they know it could be coming,” he said. “A number of state regulators in recent years have been developing new technology to help speed the examination process or to make it more efficient.”