As memories of the great recession and financial crisis fade, the landmark financial reform law passed seven years ago today, in the aftermath of that economic disaster, is on the chopping block. A Republican Congress and the Republican President are intent on rolling back the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that have increased transparency and limited risk in our financial system. The Financial Choice Act, first introduced in Congress in 2016 by Texas Representative Jeb Hensarling, is poised for a comeback.
Hensarling’s CHOICE Act, which undermines Dodd-Frank in big ways and small, is too complex and cumbersome to be considered in its entirety. Instead, major provisions are expected to be introduced in a piece-meal fashion. Key provisions slated to be rolled back are those that kept private equity funds and hedge funds out of the shadows. In the first 30-plus years of their existence as major financial actors, private funds were able to structure themselves in ways that exempted them from the many laws designed to protect investors and enabled them to avoid regulatory scrutiny by the Securities and Exchange Commission (SEC). Dodd-Frank introduced oversight and regulation that has been a boon to investors in private equity. Now, Section 858 of the CHOICE Act proposes once again exempting private equity fund advisors from registration and reporting requirements. It states, "no investment adviser shall be subject to the registration or reporting requirements of this title with respect to the provision of investment advice relating to a private equity fund."
President Trump has been a vocal critic of Dodd-Frank. In April, at a meeting at the White House with CEOs, he is reported to have said, “We are doing a major elimination of the horrendous Dodd-Frank regulations. Keeping some obviously, but getting rid of many.” With leading private equity chiefs staffing his administration, including most prominently Wilbur Ross at Commerce and Blackstone Group co-founder Stephen Schwarzman as head of his Strategic and Policy Forum, it is likely that SEC registration and regulatory oversight of the industry is something he would happily see eliminated.
While Dodd-Frank requires private equity fund advisors to register with the SEC, reporting requirements are less stringent than for publicly traded companies, and much of what fund managers report is not made public or shared with pension funds and other limited partner investors. Nevertheless, SEC examinations of PE fund advisors have identified widespread abuses. Misdeeds include manipulating the value of portfolio companies, incorrectly charging PE firm expenses to fund investors, and failing to share monitoring fee income with them. While enforcement efforts have been sporadic– just 10 settlements were reached with PE fund advisors since 2014, the SEC examinations have provided investors with an important window into the behavior of these advisors.
The Institutional Limited Partners Association (ILPA), which represents the interests of limited partners in PE funds, sent a letter to the House Financial Services Committee chaired by Representative Hensarling expressing strong opposition to Section 858 of the CHOICE Act. The ILPA pointed out in the letter that, as a result of SEC oversight and, in particular, the efforts of the SEC’s Private Fund Examination Unit, “our members have seen increased transparency and disclosure of fees and expenses by fund managers, improved fund manager compliance with the terms in the contracted investment agreements and a significantly improved culture of compliance and voluntary disclosure from fund managers.”
A law professor at the University of St. Thomas in Minnesota who surveyed private fund managers about their experiences with Dodd-Frank recently released a report. It presents his findings on the effects of changes in private investment fund regulation and assesses the regulatory implications of the Dodd-Frank Act. Surveying these managers in 2015, he found that “… the industry adapted well to the new regulatory environment in the aftermath of the Dodd-Frank Act.” While some respondents complained about uncertainty and compliance costs, most found it to be manageable. “Most importantly, 65% of private fund advisor respondents believed that their fund earnings were not affected …, and 75.4% opined that profits were not affected by the increased compliance requirements …” Thus, the survey results suggest that Dodd-Frank had a negligible effect on the industry.
Investors value the protections that the SEC’s regulatory oversight of private investment funds affords them. Private fund managers have largely adapted to the regulatory environment in the post-Dodd-Frank period. The CHOICE Act is a solution in search of a problem. It should not be allowed to threaten the progress that improved financial regulation has delivered.