Senator Chris Dodd today unveiled the latest version of his financial regulatory reform bill which, if passed, would have some implications for the venture capital and private equity markets (despite some media suggestions that PE/VC escape scrutiny).
It’s a lot like the original bill from last fall, but with exactly 200 more pages (we’ll consider this the unabridged version). Here are the relevant highlights:
1. Dodd retains the original Senate bill’s registration exemption for venture capital and private equity funds. He also retains the original bill’s edict that the SEC is responsible for constructing a definition for “venture capital” funds and “private equity” funds — so as to differentiate them from “hedge funds” (which will be required to register).
As a reminder, an earlier House bill had only exempted venture capital funds of $150 million or less. Industry trade groups had insisted that any registration would be unwarrented, given that neither VC nor PE firms helped contribute to the financial meltdown. They’re right, but hedge fund reps could have made the same argument…
2. Dodd adopts the Volcker Rule principles, which would prohibit a bank from sponsoring a “private equity” vehicle. Worth noting, however, that Dodd provides no specifics as to how this would be accomplished. For example, would Goldman Sachs be required to immediately divest the direct and secondary PE funds that have tens of billions of dollars in committed capital? If so, could limited partners in those funds trigger redemption rights on uncalled capital (due to the change in general partner)? Can Goldman itself remain a limited partner, given that its employees and clients have committed much of the money?
Dodd basically leaves the mechanics up to a new body called the Financial Stability Oversight Panel, which would be responsible for studying such regulations and then making proposals. As such, it’s still possible that the Volcker Rule could be scrapped. At the very least, Dodd punted on this one.
One interesting part of this is that Dodd specifically refers to restrictions on a bank’s ability to sponsor a “private equity” fund. Given that he distinguished between “private equity” and “venture capital” on the registration issue, it seems possible that banks could sponsor venture capital funds going forward. Very few do so, but could a VC fund-of-funds unit help supplant some of the fee income that will be lost when PE fund-of-funds go away?
Also worth noting a source’s suggestion that the ban also could apply to certain insurance companies. If true, this probably would have minimal effect, as most insurance companies invest in private equity off of their balance sheets — rather than via in-house sponsored funds (or so I’m told).
3. Dodd exempts SBIC investing from Volcker Rules. When Paul Volcker issued his guidelines, there was some concern that they would prohibit banks from making small business investments (this was particularly troubling to community banks). Today’s bill specifically permits such investments.
4. The GAO shall “conduct a study of the feasibility of forming a self-regulatory organization to oversee private funds, private equity funds and venture capital funds.” It then must issue a report to the House and Senate banking committees no later than one year after enactment of the bill.
This is almost a carbon copy of what was in Dodd’s original bill, although it continues to vex. If private equity and venture capital funds are so harmless as to not require registration, why would they need an oversight committee? As for feasibility, my guess is that the GAO report will include something about how hard it would be for such an oversight organization to operate sans fund registration…
5. Dodd retained a proposed increase to the threshhold of “accredited investors.” As I wrote earlier this month:
Section 412 would change the requirements under which someone can qualify as an “accredited investor.” Since 1982, individuals have been considered “accredited” if they had at least $1 million in personal assets and/or annual income of $200,000 ($300,000 in the case of a joint filing). Under Dodd’s proposal, however, the threshold would become subject to “price inflation” adjustments at least once every five years.
The bill does not explain the metrics that would be used to determine “price inflation,” although a 2007 SEC report used a Department of Commerce price index to project a 90% hightening of the asset floor. That same index would have caused the individual and joint income tests to increase to $388,000 and $582,000, respectively.
This would drain the angel pool a bit — particularly outside of affluent angel areas like Silicon Valley — and is strongly opposed by the National Venture Capital Association and the Angel Capital Association. I also don’t know when $1 million stopped being enough cash that a person either: (a) Is a sophisticated investor, or (b) Able to hire a sophisticated financial advisor.
6. Dodd retained language that would give state regulators authority over Regulation D offerings. As I wrote in the same piece referenced above:
This provision which would repeal the federal preemption of state laws regulating securities offerings under Regulation D. Today, a startup can raise money from accredited investors in multiple states, and file with the SEC under a common offering document. Rules overseeing the cash you raise from John in California are are the same as the ones overseeing cash you raise from Jane in Florida.
Dodd’s bill, however, would allow each state to create its own set of regulations. Not only could that become a paperwork nightmare (read: larger legal/accounting costs), but it also could delay startup fundings if one state has a longer waiting period than another. Moreover, it actually could favor startup formation in larger states at the expense of startup formation in smaller states (folks might just try to get all their cash in Cali or New York).
The only conceivable explanation here is that power-deprived state regulators threw their weight around a bit, or bought dinner for the right low-level staffer. As policy, however, it’s garbage…