Every year in late January, the Association for Corporate Growth releases its annual Public Policy Agenda—a road map that guides the organization’s advocacy efforts on public policy. As ACG gears up for an active new Congress with a Republican majority in both the House and Senate, there is a host of regulatory and legislative issues that will impact ACG’s middle-market private equity members in 2015. Here, in no particular order, are the top five public policy matters ACG members should keep an eye on this year:
1. Carried Interest in Corporate Tax Reform: While many believe that comprehensive tax reform (both individual and corporate) will not occur until 2017, it is increasingly possible that corporate tax reform could take place in 2015. This would involve simplifying the tax code by lowering the 35 percent corporate tax rate and eliminating or reducing a number of tax expenditures, potentially including carried interest.
A draft bill by former Chairman of the House Ways and Means Committee Dave Camp, R-Mich., holds that private equity fund advisers are “in the trade or business of selling businesses.” It would re-characterize a significant percentage of carried interest earned 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 Senate Finance Committee Chairman Orrin Hatch, R-Utah, all appear committed to tax reform. 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 package.
2. 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 arises with respect to: (i) fundraising activities conducted by in-house personnel and (ii) fees received by a general partner in connection with a securities-based transaction involving a portfolio company.
On the fundraising issue, 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 in 2015.
The transaction fee issue is a new subject for the SEC. The Division issued a 2014 No Action Letter regarding M&A Brokers and is studying the issue in earnest; guidance is not expected for some time. It remains to be seen whether any guidance, if issued, maintains the viewpoint that a 100 percent offset of transaction fees received by the general partner eliminates potential broker-dealer registration issues.
3. Increased Examinations and Enforcement Activity: Increasing examination and enforcement activities at the SEC has been a top priority of Chairman Mary Jo White. In a letter written in December, White noted staffing levels remained relatively stable in FY 2014, while the number of investment adviser examinations conducted 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. The FY 2015 spending bill agreed to in December is increasing funding for the SEC with a 15 percent, $150 million budget increase. The Obama Administration had requested an increase of 26 percent for FY 2015. To alleviate staffing constraints, the SEC’s Investor Advocate has called for the imposition of user fees on investment advisers to fund additional examiners.
Meanwhile, Chairman of the House Financial Services Committee Jeb Hensarling, R-Texas, has called on the SEC to spend less time and resources examining advisers to private funds.
With the additional resources, investment advisers should expect to see an uptick in examination and enforcement activities by the SEC.
4. 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 individual as well as institutional investors are 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 uncertainty. ACG submitted comments urging the SEC to withdraw its proposed rules, and leaders of the Republican-controlled House Financial Services Committee have also expressed frustration. 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.
5. Legislation to Exempt Private Equity Fund Advisers from IAA Registration: In the 113th 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-controlled Senate, the likelihood of passage of a similar bill is much greater. The White House Office of Management and Budget (OMB) 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 to avoid a presidential veto.