Dodd-Frank 30 Day Countdown: Day 10

Dodd-Frank’s Impact on Private Equity Firms – Limited Private Fund Exemption

For hedge funds and private equity firms, anxiety over the new regulations brought by Dodd-Frank pivots on Title VII and a simple dilemma: new paperwork to be done and no one to do it. However, there is a loophole.

Dodd-Frank expands the requirements on US hedge funds and private equity firms to report directly to the Securities Exchange Commission (SEC). While over 3,000 private-fund advisors are already registered with the SEC, regulators anticipate that approximately 1,000 funds with be added to the SEC’s registry, nearly half of which will include large hedge funds and big private equity firms.   Dodd-Frank not only extends the requirement on who must report, it also increases the amount of information that must be provided to regulators. Among the many additions, larger funds will now be mandated to report their total borrowings, the net asset value of every private fund, as well as monthly and quarterly performance.

With more people being held accountable to report on more information, hedge funds and private equity firms are working to establish the infrastructure and employ the systems needed to meet the new requirements of the Dodd-Frank legislation. Some private equity firms are looking to third-party appraisals in order to provide the required monthly valuations. However, given the increased workload and the illiquid nature of many private equity investments, it seems unlikely that the appraisers will be able to meet their monthly deadlines. Other firms have looked to electronic front-office systems that can provide information to investors and regulators simultaneously.

Some private equity firms may choose to rely on a “Limited Private Fund Exemption” rather than subjecting themselves to these new burdens.  This exemption allows foreign general partners to manage an unrestricted quantity of investors’ dollars without the same level of SEC reporting and scrutiny to which US general partners are subject.  Non-US general partners will also enjoy smaller overhead bills: fewer fees to the SEC and no new hires to deal with new paperwork.

The exemption for non-US general partners applies as long as the partner does not have an office in the United States.   However, as Europe moves closer to establishing regulations for private equity independent of US standards, this loophole may quickly vanish. In the meantime, investors can still find the kind of high-risk, high-reward opportunities in non-US equity firms that deal in the US market.

-This post is guest authored by Michael Yohai