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Financial Regulatory Reform -How recent changes will impact the private equity industry.

Passage of the Dodd-Frank Act, and its provisions requiring the registration of advisers to private funds, including advisers to private equity funds, has had a profound impact on the regulation of our industry. Regulatory developments outside of Dodd-Frank have also affected the regulatory environment for advisers to private equity funds, including new “Pay-to-Play” rules and amendments to the Form ADV Part 2 for registered advisers.

One of the major changes impacting the private equity industry as a result of the Dodd- Frank Act, is the elimination of the “private advisor” registration exemption, on which many private equity advisers relied.

New registration rules will require private equity advisers with more than $100 million in assets under management to register with the SEC by July 19 2011.

Advisers with between $25 million and $100 million in assets under management will be prohibited from registering with the SEC and will instead be required to register with their home states. If the adviser’s home state does not have an examination program, or if the adviser is, because of its business, required to register with 15 states or more, advisers may register with the SEC.

Advisers with less than $150 million in assets under management are exempted from registration if they advise solely private funds, defined as funds relying on the 3(c)(1) and 3(c)(7) exemptions of the Investment Company Act of 1940. This exemption will not be available to advisers that manage products other than private funds such as separately managed accounts.

Advisers to solely venture capital funds will also be exempted from registration. The SEC issued a definition of the term “venture capital fund” which will in fact preclude the vast majority of private equity firms from exempting themselves under this definition.

Advisers to family offices have received more than an exemption in that they have been exempted from the definition of the term “investment adviser.” This will have the affect of exempting them not only from the registration provisions, but from all of the other provisions, of the Investment Advisers Act of 1940.
The SEC has proposed a very narrow definition for family offices as having no clients other than “family clients,” be wholly owned and controlled by family members, and not holding itself out to the public as an investment adviser.

Advisers that will be required to register will need to:

• Develop a compliance program, including developing and implementing policies and procedures reasonably designed to prevent violations of the securities laws, conduct an annual review of those policies and procedures, and designate a Chief Compliance Officer;

• Establish, maintain and enforce a Written Code of Ethics, which must apply to the adviser’s personnel and must include provisions on standards of business conduct, compliance with the federal securities laws, reporting of personal securities transactions, and reporting violations of the Code;

• Maintain books and records, including substantial records relevant to the adviser’s business;

• Follow specific rules when entering into advisory contracts;

• Adopt and Implement a Written Proxy Voting Policy; and

• Disclose information about their advisory business, advisory personnel, fee arrangements, industry affiliations and control persons.

Additionally, advisers will have a fiduciary duty with respect to their relationships with clients and will be subject to examination by the SEC.

As a result of some of the Dodd-Frank provisions, certain advisers to private equity funds, both registered and unregistered, will be required to provide information to regulators to enable them to conduct their systemic risk monitoring activities.

Notwithstanding passage of the Dodd-Frank Act, other regulatory developments over the past year have also affected the regulation of the private equity industry in the US:
Changes to the Form ADV Part 2 – New SEC rules require registered investment advisers to provide more detailed disclosure about their activities and to provide this disclosure in a “plain English” format.These enhanced disclosures will now be available publicly on the SEC’s Web site.

Adoption of Pay-to-Play Rules – The SEC recently adopted rules which will impose limitations on certain campaign contributions and restrict the use of third-party placement agents in soliciting government plans .

Advisers to private equity funds will need to address a number of significant aspects of their business, including their compliance infrastructure, and whether the firm has the framework necessary to respond to growing demands from regulators and investors.

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