Private Fund Update April 1, 2015 Scott E. Gluck, Esq. Venable LLP Washington, DC Office: t 202.344.4426 c 540.454.4820 Los Angeles Office: t 310.229.9900 c 540.454.4820 sgluck@Venable.com www.Venable.com NOTE: The Association for Corporate Growth's Private Equity Regulatory Task Force (PERT) is having its first annual Washington, DC fly-in on May 20-21. PERT is limited to private equity compliance officers, financial officers, and in-house counsel, and the fly-in is by invitation only. For more information, please contact Amber Landis at firstname.lastname@example.org or call her at 312.957.4272. This update includes: • SEC Chairwoman White's support for mandatory third-party examinations of registered investment advisers; • Recent SEC enforcement activity relevant to private funds; and • The Senate Banking Committee's recent hearing on capital formation. Venable LLP tracks a wide range of regulatory issues, so please contact me for more information regarding anything contained in this update. The 114th Congress House of Representatives House Financial Services Committee Hearing on Oversight of the SEC's Enforcement Division – The Capital Markets and GSE Subcommittee of the HFSC held a hearing titled "Oversight of the SEC's Division of Enforcement." The sole witness was Andrew J. Ceresney, Director of the SEC's Division of Enforcement. Director Ceresney's written testimony is here; the Committee Memorandum is here; and a link to a webcast of the hearing is here. Hearing on The SEC's Agenda and Budget – The full HFSC held a hearing titled "Examining the SEC's Agenda, Operations, and FY 2016 Budget Request." The sole witness was SEC Chairwoman Mary Jo White. Chairwoman White's written testimony is here; the Committee Memorandum is here; and a link to a webcast of the hearing is here. The HFSC also passed eleven bills out of committee, mostly related to smaller banks and the Consumer Financial Protection Bureau (CFPB). A summary of the eleven bills is here. House Agriculture Committee Hearings on CFTC Reauthorization – The Commodity Exchanges, Energy and Credit Subcommittee of the HAC held two hearings on the reauthorization of the Commodity Futures Trading Commission (CFTC), one focused on end users and the other on focused on market participants. For the market participant panel, witnesses were: • Terrence A. Duffy Executive Chairman & President, CME Group • Benjamin Jackson President and COO, ICE Futures • Daniel J. Roth President and CEO, National Futures Association • Gerald Corcoran CEO, R.J. O'Brien & Associates for the Futures Industry Association • Shawn Bernardo CEO, tpSEF-Tullett Prebon for the Wholesale Market Brokers Association The Senate Senate Banking Committee Hearing on Capital Formation – The Securities, Insurance, and Investment Subcommittee of the Senate Banking Committee held a hearing titled "Capital Formation and Reducing Small Business Burdens" Witnesses were: • Thomas Quaadman Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce • William Spell President, Spell Capital Partners • Marcus Stanley Policy Director, Americans for Financial Reform • John C. Partigan Partner and Securities Practice Group Leader, Nixon Peabody The SBC held a hearing on Venture Exchanges and Small-Cap Companies. The SBC also held hearings on the Financial Stability Oversight Council (FSOC) designation process for non-banks; the regulatory regime for regional banks; and reforming the Federal Reserve. The Administration President's Proposed FY 2016 Budget The President released his proposed FY 2016 budget last week. Of particular note, the President proposes over $1.7 billion in funding for the Securities and Exchange Commission (SEC) and $322 million for the Commodity Futures Trading Commission (CFTC) – a proposed increase of over 25%. As noted previously, in the SEC's FY 2015 Budget Request, the two largest requested funding increases are for the Office of Compliance Inspections and Examinations (OCIE) and the Division of Enforcement, with Chairwoman White seeking to add 316 staff positions at OCIE and 126 at Enforcement. Securities and Exchange Commission SEC's Enforcement Priorities Include Fund Manager Conflicts of Interest Julie M. Riewe, Co-Chief of the SEC's Division of Enforcement Asset Management Unit (AMU) gave a speech in which she reiterated that the SEC is very focused on conflicts of interest in the private fund space. Riewe said that for private funds, the AMU's 2015 priorities include "conflicts of interest, valuation, and compliance and controls." She went on to state: "Likewise in the private equity fund arena, we continue to focus on the inherent conflicts in various fee and expense arrangements. In 2014, we brought our first two cases in this area. In the Clean Energy Capital case, we alleged that the adviser misallocated its expenses to funds it managed — including a majority of the principal's compensation. The money taken from the funds for the adviser's expenses was in addition to millions of dollars in management fees the fund was already paying. In the Lincolnshire Management, Inc. case, we alleged that a private equity adviser misallocated expenses between two portfolio companies owned by separate funds it managed." Riewe also raised eyebrows by stating that she expected the AMU to bring enforcement actions against private fund advisers relating to conflicts of interest in 2015. Enforcement Actions/Administrative Proceedings Undisclosed Inter-Fund Loans Amongst Affiliated Funds – The SEC settled administrative proceedings against a registered investment adviser in connection with a series of inter-fund loans made between affiliated funds. The inter-fund loans presented certain conflicts of interest for the funds' managers, and the funds' offering memoranda and limited partnership agreements did not expressly provide that the funds would make inter-fund loans. Moreover, none of the loans were documented and no terms (such as interest or maturity) were established at the time they were made. Conflicts of Interest in Recommendation of Private Fund Investments – The SEC settled administrative proceedings against a registered investment adviser arising from conflicts of interest regarding recommending that advisory clients invest in three private investment funds. Here, the RIA made false statements in the Form ADV regarding the nature of certain fees (describing them as referral fees, when they were installment payments) and understating the amount of such fees. Charges Filed Against Unregistered Broker-Dealers – The SEC charged nearly two dozen companies and individuals who regularly bought and sold securities on behalf of a suburban Chicago-based trading firm without registering with the SEC as a broker-dealer as required under the federal securities laws. The fact pattern does demonstrate that the SEC continues to focus on the issue of unregistered persons who engage in brokerage activity. Foreign Corrupt Practices Act Matter – SEC recently charged a company with violating the Foreign Corrupt Practices Act (FCPA) when its subsidiaries paid bribes to obtain sales in Africa – reiterating the importance of having robust FCPA compliance programs in place at portfolio companies that do business overseas. Investment Management Division: Key Initiatives and Guidance re: Acceptance of Gifts by Fund Personnel In March, Dave Grim, Acting Director of the SEC's Division of Investment Management, spoke at the 2015 IAA Compliance Conference in which he described key initiatives the Division is currently working on. These include potential modifications to Form ADV, such as incorporating the umbrella registration of private fund advisers as set forth in the SEC's 2012 ABA No Action Letter; business continuity plans; and stress testing for large fund managers. The Division of Investment Management also issued a Guidance Update regarding Acceptance of Gifts or Entertainment by Fund Advisory Personnel under Section 17(e)(1) of the Investment Company Act. The guidance states that the receipt of gifts or entertainment by mutual fund advisory personnel may violate Section 17(e)(1) of the ICA and encourages a mutual fund's compliance policies and procedures to include the acceptance of gifts. Even though private equity funds are not subject to the ICA, PE funds should consider including the acceptance of gifts in their compliance policies and procedures. New Chief Counsel at Division of Trading & Markets Heather Seidel was appointed Chief Counsel of the SEC's Division of Trading and Markets. The Division's Office of Chief Counsel provides legal and policy advice to the Commission on matters affecting brokerdealers and securities markets. Ms. Seidel began her securities law career at the SEC in 1996 in what was then the Division of Market Regulation, and later moved to the Division of Investment Management. She later spent several years in the private sector, then returned to the SEC in 2003. In 2006, she received the SEC's Jay Manning Award. Seidel replaces David Blass, who in 2013 gave the "A Few Observations in the Private Fund Space" speech in which he said that private equity funds might need to register as broker-dealers in connection with their (i) in-house marketing efforts and (ii) transaction fees. ACG's Private Equity Regulatory Task Force (PERT) recently met with the Division of Trading and Markets to discuss broker-dealer issues for private equity funds. Commodity Futures Trading Commission Meeting of Market Risk Advisory Committee – April 2 The CFTC's Market Risk Advisory Committee will be holding a meeting tomorrow, April 2. The meeting will focus on risk management techniques employed by Derivatives Clearing Organizations (DCOs) to ensure that the appropriate measures are in place to address the potential default of a significant clearing member and the evolving structure of the derivatives markets. An agenda for the meeting is here. Association for Corporate Growth (ACG) Meeting With SEC's Division of Trading and Markets Members of the Association for Corporate Growth's Private Equity Regulatory Task Force (PERT) met with SEC staff from the Division of Trading and Markets to discuss broker-dealer registration issues for private equity funds. The meeting included a discussion of the issues surrounding whether private equity funds should need to register as a broker-dealer in certain circumstances. InterGrowth in Two Weeks ACG's InterGrowth 2015 is two weeks away. The conference is taking place April 13-15 at the Waldorf Astoria and Hilton Bonnet Creek in Orlando, Florida. A schedule for the conference is here and a list of the roundtable discussions taking place is here. There will be a Public Policy breakout session on Tuesday, April 13 from 3:15 to 4:15. Report on Key Findings of SEC Task Force Survey ACG released the key findings of its ACG SEC Task Force Survey, which targeted private equity chief compliance, financial and operations officers, as well as in-house legal counsel. Over 200 people responded to the survey. Key findings include: • Middle-market private equity officers are concerned with a broad range of issues; • SEC presence examinations appear to have improved over time; • The SEC could improve its outreach to the middle-market private equity industry; and • Respondents want ACG's SEC Task Force to carry out a broad range of activities. ACG also held a webinar describing the survey findings in greater detail. Small Business Investor Alliance (SBIA) SBIA Western Private Equity Conference – April 23-24, 2015 The SBIA is hosting its Western Private Equity Conference on April 23-24 at the Fairmont Miramar Hotel in Santa Monica, California. An agenda for the conference is here. SBIC Regulations Class – May 7, 2015 The SBIA and the SBA will hold an SBIC Regulations Class on May 7, 2015. The class is mandatory for any fund seeking an SBIC license. To register for the class, click here. For more information, contact the SBIA at events@SBIA.org. Private Equity Growth Capital Council (PEGCC) PEGCC Releases Q3 2014 Private Equity Performance Update PEGCC released its Private Equity Performance Update for Q3 2014. The Update shows that as of September 30, 2014, returns from private equity funds (net of fees) beat the S&P 500 (including dividends) for the 10-year horizon by 5.9 percentage points. The S&P 500 outperforms the private equity benchmark return for the 1-, 3- and 5- year horizons. 2014 PEGCC Annual Report PEGCC published its 2014 Annual Report. The report notes that in 2014, PEGCC filed 11 comment letters with multiple agencies in the United States and around the world; produced its annual Public Pension Fund Analysis, which revealed that private equity produced a 12.3 percent annualized return to the median public pension over the last 10 years (more than any other asset class); and initiated a targeted, seven state Carried Interest Champions campaign to galvanize support from elected officials. Articles of Note Here are some articles you may find interesting: • The Wall Street Journal, 3/29/15 (subscription required) – "The Glory Days of Private Equity Are Over," – Argues that too many private equity funds are chasing too few opportunities, resulting in high acquisition costs. • The Wall Street Journal, 3/25/15, (subscription required) "Buyout Firms Feel Pinch From Lending Crackdown," Notes that leveraged lending guidance issued by the Federal Reserve in 2013, aimed at limiting debt in buyout transactions to 6x EBITDA have been successful in reducing high levels of debt in these transactions. • Compliance Building, 3/19/15 – "Drew Bowden Thinks Private Equity is a Great Business," – OCIE Director Andrew Bowden's remarks at a Stanford Law School PE and VC symposium, where he said that he would encourage his son to enter the private equity industry. • InvestmentNews, 3/18/15 (free subscription required) – "SEC Fiduciary Push Gives Momentum to Third-Party Exams," – Describes SEC Mary Jo White's support for third-party examinations for registered investment advisers. White believes the move would help bolster the oversight efforts of the SEC's Office of Compliance Inspections and Examinations (OCIE), which faces budget constraints. SEC Commissioner Daniel Gallagher has also expressed support for mandatory thirdparty examinations of registered investment advisors. • New York Times, "Standard Deduction," 2/18/15: "8 Tax Loopholes the Obama Administration Could Close" –Tax professor Victor Fleischer provides a list of eight changes to the tax code that the Treasury Department could enact which, in Professor Fleischer's opinion, would bring about more fairness in the tax code. These proposals include changes to carried interest, disallowing fee waivers and taxing monitoring fees as dividends. If you would like to opt out of receiving this communication, please let me know. © 2015 Venable LLP. This email is published by the law firm Venable LLP and is not intended to provide legal advice or opinion. Such advice may only be given when related to specific fact situations that Venable has accepted an engagement as counsel to address. ATTORNEY ADVERTISING.