The Dodd-Frank Wall Street Reform and Consumer Protection Act is a 2,300 page response to the recent financial crises that passed into US law last summer. Cynics might say that the bulk of the new controls are fighting the last war, and (as with the European AIFM directive) are more likely to create false reassurance and divert resources into box-ticking than to head off whatever the next threat might be.
Nor will many of us have the stomach to ask why businesses established and regulated in Europe should submit to the jurisdiction of a foreign regulator which missed so many red lights, about Bernie Madoff and junk-mortgage securitisation, at the instance of a government so dysfunctional that it will shortly have to approve an increase in the cap on its own borrowing, which has already doubled since 2004 to an eye-watering 14.3 trillion dollars!
As usual, private equity, no part of any of these problems, must duly sigh and submit. So what do we need to do? Full SEC regulation can cost many hundreds of thousands of dollars. The good news is that there are three escape routes.
A firm without a US office, and US-sourced AUM of less than $25 million (from fewer than 15 investors), can rely on the ‘Foreign Private Advisors’ exemption, and need take no action. For all other firms, the question is whether they are completely ensnared, or can escape full SEC registration as an (oxymoronically titled) ‘Exempt Reporting Advisor’.
There are two ways to achieve this. Firstly, a venture capital firm of any size, even with a US office, may be able to rely on the venture capital exemption to avoid full registration. But this exemption has been clumsily defined and in practice will catch most entities that think of themselves as VC firms. For example, 100 percent of investments must be unleveraged with non-financial value-add, and 80 percent must be primary investment. Few will escape through this hatch, unless the definition is changed in the final rules.
The second route to exempt reporting status is via the third exemption, for ‘Private Fund Advisors’. This will usually be available to firms without a US office and also to firms that do have a US office but with total AUM of under $150 million in funds advised (directly or indirectly) by that US office.
“The breadth of the exemption for Private Fund Advisers means that most non-US private equity managers – including VC managers outside the specific VC exemption – will escape registration,” explains Gregg Beechey, regulatory specialist in the financial markets group at law firm SJ Berwin. “But they will still need to make certain public disclosures, adopt certain SEC policies and would be subject to possible SEC examination visits. Some of the new policies required may come as a surprise, e.g. the new anti-pay-to-play policy.” Those seeking exempt reporting advisor status must file parts of the Uniform Application of Investment Advisor Registration (“Form ADV”) by 21 August.
Several aspects of the regime remain unclear. When they won control of the House of Representatives, the republicans proposed a new private equity exemption. This is unlikely to prevail against the democrat-controlled senate and White House, and anyway would move (some) firms from full SEC regulation down to exempt reporting status, rather than out of the net altogether.
Secondly, there can be no clarity about what changes may be needed to legal structures, governance, risk controls, operations and IT, tax, disclosures, etc. until the SEC publishes its definitive rules under the Act (including those defining relevant exemptions). In March, these were expected in April or May, but the SEC is struggling and currently the target is “in advance of July 21” (i.e. the deadline for registration!)
In this context, the SEC has recently written to the North American Securities Administrators Association indicating that they are considering pushing back the deadline for compliance until Q1 2012. The August deadline for Exempt Reporting Advisors may also now slip.
Alastair Breward is COO and compliance officer at Amadeus Capital Partners Ltd, a pan-European venture capital firm operating from the UK.