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February 24, 2014 at 08:24 AM
The SEC staff is weighing a special exemption for private-equity firms to continue collecting deal fees in the future, said the person, who asked not to be named because the deliberations aren’t public. An exemption would mean the agency is unlikely to pursue enforcement action over past deals, the person said. A final decision hasn’t been made and the agency could still require the firms to register or seek sanctions for past deals.
Related story: Federal regulation: 5 things to expect in 2014
The exemption would counter the stance of an SEC official, who signaled in a speech last year that transaction fees the private-equity industry had been taking for decades may have been improper because the firms weren’t registered as broker-dealers, a requirement under securities laws.
“I imagine that right after that speech there was reasonable blowback” from the private-equity industry, said James Cox, a professor at Duke University School of Law in Durham, North Carolina. “Regulation now usually embodies what the industry is willing to accept.”
The controversy over fees is one of the first issues that has come to light as the $3.5 trillion private-equity industry grapples with new regulatory scrutiny following the 2010 Dodd Frank financial legislation. The SEC said this month that it plans to take a closer look at advisory firms it hadn’t previously examined.
Dodd Frank
Some SEC officials argue privately that they should overlook the fees, even if they violate securities laws, because private-equity firms are now required by the Dodd Frank financial regulation law to register as investment advisors, imposing some similar investor protections.
The issue first flared up last April when David Blass, chief counsel for the SEC’s trading and markets division, said in a speech that private-equity firms’ routine practice of taking transaction fees appeared to “fall within the meaning of the term ‘broker.’”
The speech set off a flurry of calls from fund managers to securities lawyers to understand whether the speech raised issues for them and what new regulatory obligations may await, according to Amy Natterson Kroll, partner at Bingham McCutchen LLP in Washington.
Blass, speaking at an event in Washington yesterday, said SEC staff are “giving a lot of attention to the issue.”
Since Blass’s April speech, the industry has pressed for an exemption, arguing that investment advisor rules provide sufficient protections for investors, making the added broker- dealer requirements — registration with a self-regulatory organization, training for staff and additional SEC inspections — unnecessary.
SEC spokeswoman Judith Burns declined to comment.
‘Powerful and successful lobby’
“There is no question that the private-equity industry has a powerful and successful lobby, but historically, the commission has been immune from such influence, especially when it relates to past violations of the securities laws,” said Jordan Thomas, a former SEC enforcement attorney now representing a whistleblower who filed a complaint about the fees to the SEC almost a year ago.
Private-equity managers’ main compensation comes from an annual management fee of about one percent to two percent of committed capital. Beyond that, they generally receive payment based on a percentage of gains from investments, often 20 percent, after full repayment of investors’ capital.
Deal fees, which date back to the 1980s, give managers an immediate cash windfall when a deal closes, regardless of how well or poorly the investment performs over time. According to the industry’s main lobbying group, those fees still don’t turn private equity managers into broker dealers.
‘Significant costs’
