Q&A talks about efforts to modify the Dodd-Franks Wall Street Reform and Consumer Protection Act with Marc Reich, president of Ironwood Capital, a private equity firm in Avon.
Q: You testified recently before the U.S. House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises urging protecting the lower middle market from costly regulatory burdens such as SEC registration, so that small private equity investment funds can keep capital flowing to small business. What’s the thrust of your argument?
A: I testified on behalf of the Small Business Investor Alliance (www.sbia.org) that a clear, thoughtful and relevant body of regulation is essential to the consistency, predictability and smooth operation of the securities industry. Good governmental regulation is a relative strength of our system. But that regulation must be appropriate to the context to which it is applied; it should not be redundant or conflict with other regulations, and it should not adversely impact the flow of capital — in this case, the flow of capital to U.S. small businesses. The Small Business Capital Access and Job Preservation Act (H.R. 1105) seeks to modify certain aspects of the Dodd-Frank Wall Street Reform and Consumer Protection Act that are inappropriate for private equity firms, particularly middle market private equity firms. H.R. 1105 will address the many unintended consequences of Dodd-Frank that impede the flow of capital to small businesses and do not provide any protection to investors or the financial system as a whole.
Q: You testified the lower middle market should be exempt from SEC registration because lower middle market and middle market funds are not a systemic risk to the financial system. Isn’t there still a risk to the investor?
A: There is risk involved in every form of investing and private equity is no exception, but the risk in private equity is not the systemic risk Dodd-Frank and Congress seek to root out of the U.S. financial system. Every time we invest in a company there is the risk the company may go out of business, causing us to lose on the investment. That’s bad news for us, and our institutional investors, but the failure of one company rarely shakes the overall economy. Private equity, particularly middle market private equity, is actually a stabilizing factor in the financial markets, making long-term investments to help companies grow and expand jobs. Congress is rightly concerned about systemic risk caused by large-scale trading in synthetic financial instruments, wild speculation in currencies and commodities, and investment schemes that risk people’s retirement funds. However, investors in the private equity funds I manage are not individual investors; instead they are large and sophisticated financial institutions — insurance companies, public and corporate pension funds, university endowments — adept at evaluating risk and strong enough to absorb significant losses and downturns in the economy. Private equity is a systemic strength of our economy, not a systemic risk.
Q: In your testimony you said many SEC rules are one-size-fits-all and inapplicable to the private equity industry. What are some examples of these rules?
A: Private equity firms invest almost exclusively in privately held companies and hold securities that are not readily marketable or otherwise transferrable; in fact, most are impossible to sell without at least the acquiescence of the company. Nonetheless, we are required by Dodd-Frank to comply with SEC custodial rules requiring us to hire a third-party custodian to “safeguard” untradeable securities, something we’ve been doing for years by placing them in a fireproof vault. If our securities ended up in the hands of unscrupulous people seeking to profit from them, nothing would happen. We also are now required to retain and archive all e-mail messages, then review them to detect illegal activities such as insider trading. Again, we don’t hold anything that’s tradable. This is purely a regulatory exercise with no benefit to investors.
Q: You were specifically speaking in favor of H.R. 1105, the Small Business Capital Access and Job Preservation Act. The bill will help private equity funds by removing unnecessary regulatory burdens that tie up precious resources and waste investor capital that would otherwise be directed toward growing small businesses. What are its odds of passage?
A: Unfortunately, I can’t predict the outcome of the legislative process. But a failure to pass H.R. 1105 will increase the cost of regulatory compliance for private equity firms, which will cause some firms to exit the private equity business and many others to increase the size of their future private equity funds to offset the increased cost of regulatory compliance. A trend of more large funds and fewer small funds means that more capital will be made available to large companies and less capital made available to small businesses. By concentrating more capital in the hands of fewer fund managers, Congress is creating additional systemic risk, not reducing systemic risk. Everyone emphasizes the importance of small business in creating jobs, but Congress’ lack of action could imperil this vital segment of our economy.
Q: There is a group called Americans for Financial Reform that says elements in the bill that require that heavily leveraged private equity funds would still be registered would not provide effective protection against any of these outcomes. How would you respond to that?
A: U.S. Congressman Jim Himes (CT-4), the co-author of H.R. 1105, was instrumental in adding the 2-to-1 leverage ratio registration exclusion cap in the bill, mostly in response to the claims that highly leveraged private equity firms should still be registered. We think he struck a good balance, and we are pleased that he is taking a leading role on this legislation.
