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10 Key Issues For Private Equity In 2015
Law360, New York (January 02, 2015, 11:56 AM ET) --
With a new year upon us and a new Republican majority in both the
House and Senate, there are a host of regulatory and legislative issues
that will impact the private equity industry in 2015. Here, in no
particular order, are 10 regulatory and legislative matters that private
equity professionals should keep an eye on this year.
1. Increased Examinations and Enforcement Activity
Increasing examination and enforcement activities at the
U.S. Securities and Exchange Commission has been a top priority of
SEC Chairwoman Mary Jo White. In a letter written in December,
Chairwoman White noted that even with staffing levels remaining
relatively stable in FY 2014, the number of investment adviser
examinations conducted by the SEC increased approximately 20
percent from the previous year.
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 the chairwoman seeking to add 316 staff positions at OCIE and 126 at Enforcement.
Tucked inside the massive FY 2015 spending bill agreed to in December is increased funding for the SEC
and the Commodity Futures Trading Commission: a $150 million budget increase for the SEC and a $35
million increase for the CFTC — representing an increase of over 15 percent for the CFTC. The SEC’s
Investor Advocate has called the funding increase “helpful ... [but] insufficient to provide the full level of
examination coverage that is needed,” and is likely to continue calls for the imposition of user fees on
investment advisers to fund additional examiners.
With the additional resources, investment advisers should expect to see an uptick in examination and
enforcement activities by both the SEC and CFTC.
A related item worth following involves third-party compliance audits. In her December letter,
Chairwoman White noted that SEC staff is evaluating ways to supplement its examination program,
including potentially permitting or even requiring third-party audits or compliance reviews of investment
Scott E. Gluck2. Agency Guidance on Regulations and Final Rulemakings
Since passage of the 2010 Dodd-Frank Act, the SEC has issued a number of guidance updates, compliance
and disclosure interpretations (CDIs), no action letters and, increasingly, speeches that impact the
regulation of private equity funds. Thus, in 2014 the SEC’s Division of Investment Management issued
additional guidance on application of the Rule 206(4)-2 Custody Rule to Special Purpose Vehicles and
Escrows and on the Rule 206(4)-1(a)(1) Testimonial Rule; the Division of Corporate Finance
issued additional CDIs regarding Rule 506(c) general solicitations (see below) and the “bad actor”
provisions of Rule 506(d); and the SEC issued a helpful no action letterconfirming a “knowledgeable
employee” under Rule 3c-5 of the Investment Company Act of 1940 may include a broad range of firm
professionals — thereby allowing these individuals to invest in funds associated with their firm.
The private equity industry is seeking additional guidance from the SEC on a number of rules and
requirements under the Investment Advisers Act and other statutes. It is possible that such guidance, if
issued, could help reduce the regulatory burden on fund managers — particularly compliance personnel.
The SEC also still needs to finalize several rules under Dodd-Frank that could impact the private equity
industry, including the multi-agency rule on incentive-based compensation arrangements.
3. Corporate Tax Reform
While many continue to believe that comprehensive tax reform (both individual and corporate) will not
occur until 2017, it is possible that corporate tax reform could take place in 2015. This would involve
simplifying the tax code by lowing the 35 percent corporate tax rate and eliminating or reducing a number
of tax expenditures, potentially including carried interest and/or the deductibility of interest on corporate
Central to the discussion will be a draft bill (a summary is here) released last year by the former chairman
of the House Ways and Means Committee, Dave Camp, R-Mich. Camp’s proposal maintains that private
equity fund advisers are “in the trade or business of selling businesses,” and would recharacterize a
significant percentage of carried interest earned by private equity investment advisers as ordinary income
rather than capital gains. Under Camp’s proposal, real estate funds would continue to enjoy capital gains
treatment on carried interest.
President Obama, incoming House Ways and Means Committee Chairman Paul Ryan, R-Wis., and
incoming Senate Finance Committee Chairman Orrin Hatch, R-Utah, all appear committed to tax reform
(in December, Senator Hatch issued a lengthy report on the subject).
President Obama has said that he will deliver additional details on corporate tax reform in his Jan. 20
State of the Union address. For years the Obama administration has sought to change the tax treatment
of carried interest from capital gains to ordinary income, and this will continue to be a priority for the
administration in any tax reform proposal. Other potential provisions of a corporate tax reform deal
relevant to the private equity industry include reducing or eliminating the deductibility of interest on
corporate debt, slowing the allowable depreciation of assets and limiting the deductibility of advertising
expenses.4. The AIFMD Passport
Under the Alternative Investment Fund Managers Directive (AIFMD), currently non-European Union
alternative investment fund managers (AIFMs) may only market alternative investment funds (AIFs)
within EU-member states by complying with the “private placement regime” of that member state. This
means that non-EU AIFMs and EU AIFMs marketing non-EU AIFs must comply with a difficult patchwork of
divergent regulations to market their AIFs throughout the EU. It appears that many non-EU AIFMs have
decided not to market in the EU due to the difficult regulatory environment.
In November, the European Securities and Markets Authority (ESMA) issued a Call for Evidence regarding
the pan-EU marketing passport currently available to EU AIFMs. By July 2015, ESMA is required to issue
advice on whether the passport should be available to non-EU AIFMs and AIFs. As a practical matter, the
final form of the AIFMD passport for third-country AIFMs will play a large role in determining the extent to
which non-EU AIFMs choose to market their funds within the EU. Several associates, including the Private
Equity Growth Capital Council (PEGCC) and the Institutional Limited Partners Association (ILPA) will be
submitting comment letters urging ESMA to support broad application of the pan-EU marketing pass.
5. Broker-Dealer Registration
In 2013, David Blass, then-chief counsel for the SEC’s Division of Trading and Management, gave a
speech stating that private equity firms need to consider whether their activities require them to register
as broker-dealers under the Securities Exchange Act of 1934. The issue potentially arises with respect to:
(i) fundraising activities conducted by in-house personnel, and (ii) fees received by a general partner in
connection with securities-based transactions involving a portfolio company.
The SEC is further along in studying the fundraising issue, where the SEC’s primary concern is unregistered
employees receiving a commission or other compensation directly tied to the success of the fund’s
marketing activities. The SEC is expected to issue guidance on this issue at some point.
The transaction fee issue is a relatively new one for the SEC. The division issued a 2014 No Action Letter
regarding M&A Brokers and is now studying the issue in earnest with guidance not expected for some
time. With David Blass no longer at the agency, it remains to be seen whether any guidance, if issued,
maintains the position that a 100 percent offset of transaction fees received by the general partner
eliminates the issue.
6. Additional General Solicitation Rulemaking?
The 2012 Jumpstart Our Business Startups (JOBS) Act lifted the ban on general solicitations and, for the
first time, gave private equity investment advisers the ability to market their funds to the general public.
The SEC’s final rule implementing the law created a new Rule 506(c) category of offerings under Reg D,
which advisers may take advantage of to market their fund(s) more broadly, so long as the adviser takes
reasonable steps to verify that investors are accredited investors and all investors are, in fact, accredited
Simultaneous with the final rule, the SEC proposed new regulations that would impose significant
restrictions on fund managers seeking to conduct a 506(c) offering. To date the proposed regulations on
506(c) offerings still have not been finalized, creating regulatory uncertainty. Industry organizations,
including the Association for Corporate Growth, the Private Equity Growth Capital Council and Small
Business Investor Alliance submitted comments urging the SEC to withdraw its proposed rules, and several members of Congress have also expressed concern with the proposed rules. The SEC is expected
to issue a final rule in 2015, but it is also possible that the new Congress will provide statutory clarification
eliminating at least some of the proposed regulations — such as a 15-day prefiling of a Form D prior to
undertaking a 506(c) offering.
7. Business Development Company Reform
Last Congress, the House Financial Services Committee passed a bill on a party-line vote that would make
significant changes to the regulation of business development companies under the Investment Company
Act. H.R. 1800, the Small Business Credit Availability Act, would have streamlined the registration and
offering process by, among other things: allowing BDCs to: incorporate already filed information by
reference; obtain “well-known seasoned issuer” status; use free writing prospectuses; and prefile shelf
registration statements for continuous or delayed offerings.
While most of the provisions had strong bipartisan support, the legislation also contained two
controversial items: reducing the asset coverage ratio for BDCs from 200% to 150 percent and allowing
BDCs to own interests in registered investment advisers. With a Republican Senate, it is likely that some
version of BDC reform will pass this Congress, but it is unclear whether the final version of the legislation
will include the two controversial provisions.
8. Financial Stability Oversight Council
The Financial Stability Oversight Council (FSOC) has the ability to designate very large nonbank entities as
systemically important financial institutions (SIFIs), imposing enhanced prudential regulation and capital
standards on an entity so-designated. After focusing on very large lenders (GE Capital) and insurance
companies (AIG,Prudential%20Financial%20Inc.pdf">Prudential Financial and, as of
December, MetLife%20Public%20Basis.pdf">MetLife), FSOC is now turning its attention to the asset
At its December, 2014 meeting, FSOC announced it will be seeking public comment on potential risks to
U.S. financial stability from asset management products and activities. It its recently published Notice
Seeking Comment, FSOC requests information on: risks associated with liquidity and redemption,
leverage, operational functions and resolution. Although the notice appears primarily focused on hedge
funds and other asset managers, this is an area that managers of large private equity funds should be
keeping an eye on, particularly because the burdens associated with SIFI designation are so significant.
9. Legislation to Exempt Private Equity Fund Advisers from IAA Registration
Last Congress, the House of Representatives approved H.R. 1105, the Small Business Capital Access and
Job Preservation Act, which would have exempted investment advisers of private equity funds from
having to register with the SEC under the Investment Advisers Act of 1940. Despite the relatively strong
bipartisan vote of 254-159, the legislation was not taken up by the Senate.
With a new Republican Senate, passage of a similar bill is much greater. The White House Office of
Management and Budget recommended a veto of the prior bill, so it remains to be seen whether an
identical version of the bill passes or if changes are made in order to try and avoid a presidential veto. If
the bill is passed, the SEC could be tasked with defining a “private equity fund,” much like it had to come
up with the definition of a “venture capital fund.”10. Changes to the Definition of an Accredited Investor
In 2010, Congress made it more difficult for individuals to qualify as an “accredited investor” under the
Securities Act of 1933 by excluding the value of the primary residence from the net worth calculation. Last
October, the SEC’s Investment Advisory Committee approved five recommendations regarding the
definition of an accredited investor, some of which could have a material impact on who is able to qualify.
Some of the potential changes, such as enabling individuals to qualify based on financial sophistication,
could increase the pool of accredited investors, while others, such as increasing the dollar thresholds,
could significantly decrease the pool. The Small Business Investor Alliance submitted a comment
letter urging the SEC not to adopt any changes which would limit the definition, thereby negatively
effecting the ability of funds to raise capital.
—By Scott E. Gluck, Venable LLP
Scott Gluck is counsel in Venable's Washington, D.C., and Los Angeles offices.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its
clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general
information purposes and is not intended to be and should not be taken as legal advice.
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