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SEC Compensation Rule Could Affect PE

The Securities and Exchange Commission proposed a rule on March 2 that could require firms with $1 billion or more of assets to disclose how they pay professionals who help make investment decisions.

Though the SEC’s press release on the rule doesn’t mention private equity by name, it says the rule would apply to financial institutions, broker-dealers and investment advisers with $1 billion or more in assets. Under the Dodd-Frank financial reform law, private equity firms with $150 million or more of assets under management have to register as investment advisers.

The SEC is proposing the rule as a way to tamp down the type of excessive risk-taking that helped facilitate the financial crisis in 2008. The rule would also affect major banks, brokerage firms and hedge funds, according to The New York Times.

The SEC could effectively prohibit firms from maintaining incentive-based compensation agreements if the agency believes they encourage inappropriate risks under the rule, which the SEC rolled out as part of Dodd-Frank. It could also result in the disclosure of sensitive payment agreements with certain executives, though it’s not clear yet if the SEC would keep the disclosures confidential.

The proposal would mean more federal oversight as a result of Dodd-Frank for an industry that has historically preferred to keep its business practices private. Most firms are already preparing to register as investment advisers as part of Dodd-Frank, which entails filing annual paperwork, developing compliance policies, keeping tighter records and submitting to SEC examinations, among other obligations.

Should the rule go into effect, the SEC would effectively insert itself into compensation agreements already contractually agreed upon between pensions, endowments and other investors in private equity funds and the managers of the funds, Rob Morris, a managing partner with Olympus Partners, told Buyouts. Limited partners typically commit a certain amount to private equity funds, and inherent in that agreement is acknowledgement of the risk the firm is taking and how much money the general partner will pay its investment staff if it succeeds, Morris said.

“The SEC is saying, ‘No, the investor is not smart enough, we’re going to look at this and decide if you’re over-compensating the manager for succeeding when taking a defined amount of risk,'” Morris said.

Officials at the SEC were not immediately available for comment.

The proposed rule has tighter restrictions for financial institutions with $50 billion or more in assets. For example, it would require these firms to defer for three years at least 50 percent of any incentive-based compensation for executive officers, and award such compensation no faster than on a “pro-rata basis.”

Morris said he expects the rule to face withering criticism from Republicans in Congress who already see Dodd-Frank as overreaching into the private sector.

The rule will soon enter a public comment period of 45 days.