SEC Regulates Hedge Funds VCs Worry They Are Next

The Securities & Exchange Commission last week voted to regulate hedge funds, as anticipated, but the impact on other private equity investments, particularly venture capital, is minimal. At least for now.

“A carveout was made in the language of the rule to exempt institutional investors in private equity. Most private equity and venture capital funds are not covered by the regulation,” says Marco Masotti, a partner in the law firm of Paul Weiss Rifkind Wharton & Garrison in Manhattan. He adds that state pension funds and other institutional investors are specifically protected in the rule, should they be forced to redeem investments in a VC fund in under two years due a statutory requirement.

The final rule – which has yet to be published by the SEC – will take effect in February 2006. “We’re going to read the publication of the rule very carefully,” says Masotti, “to see what final tweaks and changes may be made before final publication.” His law firm helped clients file comments against the rule.

In an at-times acrimonious open hearing on Oct. 28, Chairman William Donaldson led the SEC to a 3 to 2 vote to regulate hedge funds, as predicted by many industry observers (see PE Week, 8/2/04 issue), ignoring the recommendation from the National Venture Capital Association (NVCA).

Jennifer Dowling, vice president for federal policy at the NVCA, says that the association was “pleased with the carve-out in the rule,” which makes a distinction between hedge and venture funds related to redemptions.

“While we haven’t seen the final language, I am convinced that our concerns relating to the possible inclusion of VCs under the rule if they liquidate their investments in under two years is addressed,” Dowling says.

While some see the rule as a step toward eventual regulation of venture and buyout funds, David Goldstein, a partner at White & Case in Manhattan says, “The rule doesn’t have a lot of bearing on other forms of private equity.”

Goldstein adds that the SEC is unlikely to move further in the direction of regulating private equity based on the regulation of hedge funds.

“The impact on other forms of alternate investments is marginal,” says Goldstein, who represented clients for whom his firm filed comments against the rule.

Commissioner Paul Atkins rhetorically asked in the open hearing why the SEC had refused to extend the comment period to 90 days, as requested by the NVCA, which would have allowed for more comments or an amending of the rule. He answered his own question when he remarked that the rule was “written in stone; decided, before comments were even written.”

Atkins also raised the issue in the pre-vote hearing, of why venture capital funds are not included in the regulation, saying that if valuations [of portfolio companies] are one cause of the regulation, then VC and other forms of private equity should raise as much concern as hedge funds.

Atkins said that the only real distinction between hedges and other forms of private equity, such as venture capital – left unregulated by the rule – was the timing of redemption. Making a distinction along the lines of a two-year rule does not capture the distinction between such funds, he said.

Joining Atkins in his dissent, Commissioner Cynthia Glassman said in the open hearing that the regulation is “a disappointment, rushed through requisite procedures and largely seen as a fait accompli even before Tuesday’s vote.”

Glassman said that passage of the rule would have the effect of opening private equity investing to an ever wider group, thus having the opposite impact of the intention of those voting in its favor.

“It is the wrong solution to an undetermined problem,” said Glassman, who added that she was “troubled by the minimization of the concerns expressed by those opposing the regulation.”

The New Jersey State Investment Council and the Ohio Public Employees Retirement Fund both supported Donaldson’s recommendations, lending credibility to his assertion that public pensions, representing millions of retirees, are increasingly involved with and becoming dependent upon private equity asset class investments.

The rule, an audio webcast of the hearing and published versions of testimony are available on the SEC website at