Private equity firms have been quietly flying under the radar of Washington regulators until recently when the Dodd-Frank Act widened the scope of targeted financial firms for imposing new rules on compensation. At the heart of the financial reform law are proposed rule changes that would apply to all financial firms with $1 billion of assets and place their compensation activities under the review of the SEC. That new parameter suddenly turns the once stealth private equity firms into a bright blip on the radar, but they’re not going to be easy targets. The industry has unleashed a series of strong rebuttals through a lobbying effort that it hopes will get them out of range once again.
Under the new law, the SEC was given a broad mandate to develop new rules designed to restrain the kind of excessive
pay that the law contends led to the type of extreme risk-taking that led to the financial meltdown. Although its primary targets are the larger financial institutions that were at the center of the crisis, its broad scope encompasses any financial firm that manages at least $1 billion, and that reaches most of the established private equity firms.
Through its advocacy group, the Private Equity Growth Capital Council, the industry has put forth several salient arguments in their request for immunity from the act. First, while they will concede their compensation can be fairly generous, it is dwarfed by the big banks and investment houses. Coupled with the fact that their compensation is derived through direct negotiations with third party stakeholders, they feel as though there are sufficient checks on their pay practices. They draw a stark comparison to the arbitrary and unilateral methods employed by Wall Street management to determine the size of bonuses.
Also at issue is the law’s contention (or presumption) that all $1 billion non-bank financial firms pose the same systemic risk to the economy. The private equity industry has fired back saying that they do not belong within that generalization because they don’t interact with the big banking firms and they employ very little leverage in their fund activities.
Their most targeted argument is directed at the possibility that the SEC, following its review of any incentive-based compensation plan, could simply disapprove it, and require that, any substantial pay be deferred over three years. The private equity industry is countering with its argument that carried interest, which is deferred profit, is already a form of deferred compensation, and, therefore, shouldn’t be included in the broad classification of incentive-based compensation. While this argument may hold the most water, considering the big red tax target the President and Congressional democrats have painted on carried interest this year, it won’t be an easy sell.
