AIC Key Regulatory Priorities
Investment Advisers are Not Broker-Dealers:
The AIC urges the SEC to confirm that broker-dealer regulations do not apply to private equity investment advisers merely because they may receive fees in connection with the acquisition, financing and sale of the portfolio companies they control.
Private equity investment advisers are not broker-dealers. They provide investment expertise and advice to their affiliated funds and portfolio companies, are subject to fiduciary duties, and do not engage in traditional brokerage activities. Receipt of fees in connection with the purchase or sale of portfolio companies alone does not transform a private equity sponsor into a broker. The AIC believes that this confusion can best be resolved through a no-action letter that will confirm, subject to certain conditions that have largely been addressed in precedent, that private equity sponsors are not required to register as broker-dealers merely because they receive such fees.
The AIC urges the SEC to reform Form PF to reflect the fact that private equity investment advisers, funds and their portfolio companies pose no systemic risk. This will reduce unnecessary reporting burdens on private equity without compromising investor protections.
Private equity fund sponsors should be relieved from the burden of responding to Section 4 of Form PF, which requires detailed reporting on portfolio companies. Private equity funds and sponsors are not systemically important, nor is leverage at the portfolio company level a means of assessing systemic risk. Therefore, there is no reason to require private equity fund sponsors to collect and provide detailed and burdensome information on their portfolio companies as required by Section 4. Indeed, the burdens associated with the Section 4 data collection process can be significant. In addition, the focus on leverage at the portfolio company level as a means of assessing systemic risk is misplaced. Information concerning portfolio company leverage is irrelevant to the assessment of whether a private equity fund sponsor might pose systemic risks, as the leverage of a private equity fund portfolio company is not cross-collateralized or guaranteed by either the fund or its other portfolio companies. There is nothing unique about a lender’s loans to private equity portfolio companies that would make them more risky than a wide range of other types of loans made by the lender to other companies owned by public shareholders, public companies or other institutional investors.
The AIC urges the SEC to clarify the applicability of its auditor independence rules in the private equity context to reduce the detrimental effects on capital formation caused by the current expansive scope of the rules.
The SEC’s auditor independence rules strictly limit accounting firms in both the non-audit services they can provide and the relationships they can have with audit clients. As these rules are applied in the private equity context, however, the combination of the rules’ broad definitions of “accounting firm,” “audit client,” and “affiliate of the audit client” can lead to the application of these independence restrictions across private equity groups and can have implications on selection and retention of accounting firms for both portfolio company and fund audits. In particular, because of the rules’ “up and over” application, an independence issue at a single fund’s portfolio company can needlessly impair an auditor’s independence, causing significant problems for other funds and portfolio companies in the group. The AIC plans to engage further with the SEC on this topic to obtain clarifying relief.
The AIC urges the SEC to update the Custody Rule to remove unnecessary burdens.
The SEC’s Custody Rule (Rule 206(4)-2) imposes many unnecessary burdens on private fund sponsors with respect to the custody of privately offered or restricted securities (which are not readily transferable and thus not at risk of misappropriation) and smaller friends-and-family funds (where the cost of complying with the Custody Rule outweighs the protection that it provides). At the request of the AIC, the staff of the SEC’s Division of Investment Management (“IM”) has already addressed certain Custody Rule issues our members faced through interpretative guidance. We believe that IM should also address the issues described above through interpretative guidance. If they are not able to do so, we believe the SEC should consider rule amendments to substantially reduce unnecessary burdens imposed by the Custody Rule on private equity funds.
The AIC urges the SEC to modernize the Advertising Rule to better meet the demands of the 21st century.
The SEC’s Advertising Rule (Rule 206(4)-1), which has not been amended since its adoption in 1961, was designed to address advertising practices generally used by an investment adviser with respect to retail clients. The Rule places limitations on the ability of private equity fund sponsors to present case studies and other relevant information or references from investors, even though advisers are still subject to liability for false or misleading statements to investors or prospective investors under IAA Rule 206(4)-8 and other provisions of the federal securities laws. The AIC understands that the SEC will be addressing the Advertising Rule as part of its long-term agenda and we look forward to engaging with SEC staff on this issue.
The AIC urges the SEC to simplify the verification of investor status and provide further assurances on what constitutes “general solicitation” to allow for normal business reporting without unwarranted scrutiny.
While we applaud the SEC for removing from its regulatory agenda a rule proposal that would have imposed additional burdens on private funds and other issuers offering securities in reliance on Regulation D, we believe more needs to be done. For example, the guidance that the SEC provided on the verification requirement in Rule 506(c) under the Securities Act of 1933 has not allowed the benefits contemplated by the JOBS Act (which directed the SEC to amend Regulation D to permit general solicitations and general advertising in offerings made under Rule 506) to be fully realized by investors. The AIC will engage with the SEC to explore ways in which the means for verification of an investor’s status as an accredited investor can be made less burdensome.
In addition, we believe the SEC’s providing greater certainty concerning the application of the “general solicitation” prohibition in Rule 506 to public company business communications to equity and debt holders and others would be desirable. For example, in order to avoid any chilling of the free flow of such information, the SEC could adopt a safe harbor that would clarify that communications containing routine factual business information by a fund sponsor concerning fund investment results, portfolio company transactions, the status of fund raising, or the sponsor’s business plans would not constitute a general solicitation.
The enactment of tax reform legislation in late 2017 began a second phase of tax reform in the regulatory space. The private equity industry, working through the AIC, will be working over the coming year and beyond to ensure that regulatory matters and clarifications needed to effectuate the intent of the tax reform legislation are addressed expeditiously by the Department of Treasury and the Internal Revenue Service.
The AIC is the voice for private equity in the United States, but we also work to ensure U.S. private equity firms and the funds they manage receive fair treatment in other countries. We agree with the U.S. Treasury Department that a core principle of U.S. regulation should be to advance American interests in international financial regulatory negotiations. Moreover, “U.S. engagement in the [Financial Stability Board] and international financial regulatory [standard-setting bodies] remains important to . . . level the playing field for U.S. financial institutions, and prevent unnecessary and overly burdensome regulatory standard-setting that could stifle financial innovation.”
In particular, we encourage the SEC to ensure that the Financial Stability Board and the International Organization of Securities Commissions continue to recognize that private equity firms and funds are not sources of systemic risk. We also believe the SEC should encourage European regulators to allow U.S. private equity fund sponsors to have access to European investors and markets with flexibility, through “passporting” and retention of national private placement regimes.