LPs welcome Dodd-Frank but GPs worried

Susannah Birkwood
16 September 2011

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It may be more cumbersome regulation which will see scores of PE firms tightening their compliance regimes over the coming weeks, but a raft of LPs are embracing the introduction of the Dodd-Frank Act. Susannah Birkwood reports

A large number of investors appear to be viewing the advent of America's Dodd-Frank Act as a positive way of ensuring adequate disclosure from European private equity firms.

The regulation, which comes into effect in mid-February 2012, requires all GPs with at least one employee based in the US and 15 or more US-based investors with more than a combined $25m invested to register with the Securities and Exchange Commission (SEC) and become subject to the Investment Advisers Act of 1940.

Though it will hit the industry around the same time as a horde of other measures (including the AIFMD, FATCA, the UK Bribery Act and Solvency II to name but a few), there is a belief among private equity LPs that Dodd-Frank will give investors an additional layer of protection. "It probably does," admits Bill Thomas, a US-based partner at law firm Gibson, Dunn & Crutcher. "There are a lot of investors in PE funds who are happy that firms will be regulated, who want to be investing in regulated managers, and want to make sure they all comply. I can't think of any disadvantages for LPs, as normally the firms will not be able to pass costs up." Lisa Cawley, a UK-based partner of Kirkland & Ellis, believes LPs investing in the US are more likely to be pleased, because many American fund managers aren't yet SEC registered (unlike UK firms, which are already regulated by the Financial Services Authority).

GP grumblings

The reaction among GPs themselves has predictably been less than welcoming, however. More than a handful of PE firms have even been implicated by having just one or two employees located in the US. "The people who are caught are not thrilled," says Cawley. "It has felt like a really tough couple of years of additional regulatory and cost burden for firms. There's been an awful lot for the industry to try and grapple with." Furthermore, although Dodd-Frank was enacted as a way of safeguarding against another global economic meltdown, the frustration for many, according to Thomas, is that PE firms "aren't the cause of the financial crisis", making it "unfortunate" they will be subject to more onerous regulation.

What's most striking when viewing Dodd-Frank against Europe's regulatory framework is the way in which firms which don't fall under the Act's umbrella still have to apply for an exemption to get themselves off the hook. Thus, although so-called "foreign private advisers" which don't have a US office will not have to register, they do have to make an SEC filing. This abbreviated version of what a registered GP will need to do involves being subject to record-keeping and reporting obligations - and even submitting to a full-blown examination if the SEC sees fit. "Under European legislation, if you're not in it, you're not in it, whereas the surprising thing with this is that you still have to do this filing and disclose quite a lot of information," comments Cawley. "In the UK regulatory context, that's odd, and has surprised a lot of people."

The scale of concern among private equity firms became apparent at a recent industry conference. An event hosted by regulation and compliance consultancy IMS highlighted how more than 75% of the 100 delegates felt "unprepared and worried" about the requirements. Both Thomas and Cawley are keen to stress that sufficient time still remains to get ready for Dodd-Frank - but firms must act now. "A lot of people in the industry, when they saw the regulation was being pushed back, put their analysis and registration process on hold for a number of months," explains Thomas. "In the summer, nothing much happened, but now we're in the autumn again, they need to get their nose to the grindstone and make some determinations about which entities they're planning to register."

One way that some US firms are dodging the full force of the Act is by carving out parts of their businesses and establishing new subsidiaries to manage them, while several PE managers are relocating their US-based staff members to Europe. Others are towing the line more obediently in hiring external compliance consultants to do a mock-audit of their policies, so they're prepared when the SEC knocks at the door. "If you're living in a very European-centric world, and are not concentrating on your US side when you fundraise, you maybe aren't as focused on this as transatlantic law firms are," adds Cawley. "It is not too late to register or file if you start now, but it is time for firms to get focused."