Five things you need to know about private equity


, Alabama

This week marks the official anniversary of the Dodd-Frank Act – sweeping legislation adopted in response to the prolonged economic recession beginning in 2008. Dodd-Frank was passed to reduce systemic risk within the financial markets and protect investors from future financial crises; a goal everyone agrees was commendable. However, in the years since it was passed, it has become painfully clear that the Act has failed to achieve all of its intended goals and has created some unintended consequences. An all-encompassing law, the Act took a generalized approach to regulating complex capital markets, with little thought given to the consequences. Historically misunderstood, private equity is a perfect example of how Dodd-Frank’s generalized approach has been misapplied to an industry that, more than most, has served Americans by growing companies, creating jobs and supporting pension funds and endowments and those who benefit from them.

As we mark the fifth anniversary of Dodd Frank, let’s take time to review five ways that the Act has impacted the mission of private equity. These assessments are based on quantitative and qualitative data, compiled by the Association for Corporate Grown (ACG), and its members:

1. Dodd-Frank was rushed and missed the mark

In haste to pass a bill in response to the economic crisis, Congress did not acknowledge the different forms and merits of capital market providers. Like venture capital, private equity represents committed funds; when there is an opportunity to invest in a company, a private equity fund must make a capital call to its investors. Venture capital and private equity are structured very similarly, yet only one – private equity – was swept into having to register as an “investment adviser” by Dodd-Frank and is now subject to burdensome regulation.

2. Private equity does not add systemic risk

Private equity firms take an ownership position, provide capital to midsize private operating companies and help them grow. Yes, this translates to more American jobs and increased sales and based on recent data from GrowthEconomy.org, the country has marked more than 760,000 new jobs from 1995 to 2013 because of private equity’s long-term investments in operating companies.

3. Over regulating private equity does not give investors added protection

Dodd-Frank’s intention to protect investors is admirable. Most investors in private equity are foundations, public and private pensions and college endowments. As with any business, quality customer service and a happy end user results in repeat business. Regulating private equity has not enhanced the robust and highly rigorous due diligence process already performed by PE’s sophisticated investors, before committing to a ten-year partnership. This due diligence is precisely why private equity outperforms most other investments over 3, 5, and 10 year periods.

4. Regulation has changed the structure of private equity firms – taking their eye off the ball

Dodd-Frank has caused small and midsize private equity firms to divert resources from investing activities to navigating the Act’s complex regulatory framework. Instead of focusing on what private equity does better than any other investment class – providing returns for investors – private equity firms have been forced to spend roughly $100,000 annually on compliance. Like the grade school bully who took your lunch money, Dodd-Frank forced private equity to reallocate resources meant for generating returns for investors and their beneficiaries, to complying with the Act’s overregulation.

5. Dodd-Frank isn’t all bad

Despite several clear deficiencies, Dodd-Frank hasn’t been a complete bust. It reinforces a culture of compliance and disclosure – a positive step for the 1,000+ middle-market private equity firms represented by ACG. Ensuring that limited partnership agreements, disclosure documents and corresponding communications are clearly written with transparency and accurate disclosure is good for everyone in the industry. It has benefited both fund managers and the investors in these funds.

Five years is an appropriate time for an honest and fair review of Dodd-Frank. While middle-market private equity firms would agree that a culture of transparency has benefited investors and enhanced best practices, this outcome could have been achieved without unduly burdensome regulations. It is time for Dodd-Frank to be fine-tuned to better fit the private equity model. Failure to do so will keep these firms squeezed by the burden of compliance, instead of focusing on innovation, growing jobs and providing returns to investors. That is not a legacy that either former Sen. Chris Dodd (D-Conn.) or former Rep. Barney Frank (D-Mass.) would likely want associated with their namesake Act.