Regulated to death

Smaller firms may be hit hard if forced to register with the SEC, writes Kevin Ley.

While many private equity firms have expressed trepidation at the plans outlined by US Treasury Secretary Timothy Geithner in March to increase federal oversight of the private funds industry, it is what he didn’t say that has many smaller firms worried.

Geithner has proposed regulations that would require leveraged private investment funds with assets over a certain threshold to register with the Securities and Exchange Commission, including reporting any information “necessary to assess whether the fund or fund family is so large or highly leveraged that it poses a threat to financial stability”.

This is not the first time the issue of increased SEC oversight has come up, as a Senate bill proposed in February would require private funds with $50 million or more in assets – including hedge funds, private equity funds and venture capital funds – to register with the SEC. Although Geithner has not yet identified what his asset-under-management threshold will be, the amount requiring SEC registration could very well be lower than $50 million.

If so it could be a crippling blow to many smaller private equity firms, especially in the venture capital field. “We don’t think that any fund with assets under management of under $50 million can afford to register, the costs are just too high,” David Lerner, a partner at law firm Morrison Cohen, says in an upcoming issue of PEI Manager examining the Geithner proposal in more detail. “You need at least two additional people on top of your other infrastructure just to manage regulatory compliance issues. Under $50 million, forget it, they’ll simply have to shut down.”

While the managing partner of one large firm said he didn’t expect the new proposals to be too burdensome, and several other longtime players have commended the SEC for improving its auditing process, if the threshold is set at the $35 million level mandated by the Investment Advisors Act, many smaller funds may not be able to handle the increasing time, costs and reporting requirements.

Although this wouldn’t be the first time that government regulations had negative unintended consequences on businesses, the survival of many firms may depend on educating politicians and the media that the private equity industry is not just composed of giants like Carlyle and Blackstone.

Recently six private equity and venture capital professionals – including from the Riverside Company, Quaker BioVentures and Blue Tree Capital Group – testified before the US House of Representatives’ Small Business Committee on how measures such as FAS 157 accounting rules and the capital gains tax hike have impeded private investment. They also emphasised their role in driving job creation, innovation and growth at small businesses.

Such publicity was a good first step, but a more sustained, coordinated outreach campaign will be needed in the future to spread the message that penalizing small private equity firms will penalize the economy as a whole.