After a furious lobbying assault by the buyout industry, Congressional negotiators crafted a compromise financial reform bill that was milder than many industry pros had feared.
The worst news: All but the smallest private equity firms will have to register with the Securities and Exchange Commission by this time next year under the bill, which at press time still faced an uncertain future. But the bill appears to have carved out enough space that many banks will be able to retain their in-house private equity operations, avoiding a disruption to the market that widespread divestitures could have caused. Earlier versions of the bill would have outright barred banks from sponsoring private equity funds under the so-called Volcker Rule.
Meantime, left unresolved is the fate of separate legislation, now stalled, that would have raised taxes on carried interest, the share of profits earned by buyout firms for their management of investor funds. “It could have been worse,” said one source who asked that his name not be used.
At press time, it appeared possible that the bill could become even more industry-friendly. After the conference committee held its final vote on June 25, 92-year-old Sen. Robert Byrd (D.- W.Va.) died, leaving Democrats short of the 60 votes they would need to overcome a Republican filibuster. Reuters, the publisher of Buyouts, reported June 29 that Democrats were considering reopening negotiations on the bill to win the needed votes.
The conference committee’s final bill—the Dodd Frank Act, named after the Senate and House committee chairmen who shepherded it to passage—will require almost all buyout shops to register with the SEC a year after the legislation is signed into law by President Obama, a ceremony expected at press time to occur over the Independence Day weekend.
The law eliminates the “private client exemption” that had allowed many buyout firms to avoid SEC registration, said David Wohl, a corporate partner in the New York office of the law firm Weil, Gotshal and Manges. Until now, a firm with less than 15 clients could avoid registration, but the legislation changes that, requiring registration by all fund sponsors, with two exceptions—firms with less than $150 million of assets under management, and venture capital firms. The VC exemption, not defined in the bill, may prompt some buyout shops to try to lobby the SEC to shape the definition of those terms.
Exactly what registration would entail presumably would be left for the SEC to decide. Money managers required to register with the SEC today under the Investment Advisers Act of 1940 must have a chief compliance officer and follow a written compliance program that covers such things as conflicts of interest, trading in public equities by employees, and the maintenance of books and records. Registered advisers also are subject to periodic SEC inspections. While the rules remain to be written by the SEC regarding what kind of records that hedge funds and private equity sponsors must keep and what kind of reports they must file, the legislation does not provide for treating such investment advisers differently; only venture capital was singled out for separate treatment under the law.
In a big victory for banks with private equity arms, financial reform negotiators stopped short of a ban on merchant banking, deciding to allow bank holding companies to invest up to 3 percent of their capital in hedge funds and private equity funds.
The provision also appears to be generous enough to allow most banks to continue their existing private equity operations rather than divesting them, which some observers had feared could be disruptive to the market.
Some of the nation’s largest banks seemed to anticipate the change. In the days leading up to the conference committee, JPMorgan Chase & Co. was reported to be in talks to buy a large Brazilian hedge fund and private equity group, Gávea Investimentos, an asset management company that manages about $5.3 billion, the Financial Times reported June 20.
At the same time, Citi Capital Advisors, a unit of Citigroup Inc., was starting to raise $1.5 billion for private equity this year and $1.75 billion for hedge funds by next year, a source confirmed to Buyouts.
Still before Congress is question of the tax treatment of carried interest, part of a separate piece of legislation, an “extenders bill” that would renew a variety of tax provisions that are expiring and would impose a variety of tax increases, including a change in the treatment of carried interest, to pay for them.
The bill was sidelined June 24 because it also was being used to extend unemployment benefits to the long-term jobless, a provision that deficit hawks objected to because it lacked a revenue component to offset the expense, “It seems there are not the votes at this time to pass what the Democratic leaders want,” said Donald E. Rocap, a partner at the Chicago law firm Kirkland & Ellis LLP.
Even while the bill was under active consideration, buyout advocates had managed to soften the provision concerning carry, so that only a portion of buyout shops’ carry—75 percent after 2013, under one version of the bill—would be taxed at the higher, ordinary-income rate while the remainder would still be taxed at the lower capital gains rates.
The risk remains, however, that Congress could launch a renewed assault on carry later this year.