Trump-Quake: Trump’s Impact on Private Equity? Part II: New Regulatory Framework
Donald Trump’s election could bring sweeping changes to existing business regulations. As a candidate, Trump pledged to “eliminate unnecessary regulations that kill jobs and bloat government.”
Most expect that financial services deregulation will take center stage early in the Trump presidency. Some of this deregulation could be welcome news for private equity funds that were swept up in the Dodd-Frank financial services reforms. However, the future is far less certain for other regulations that impact private equity investments and M&A activity in the U.S., including antitrust and national security (or CFIUS) review.
Financial Services Deregulation
Dismantling regulation of the financial services industry is likely to be an area of particular focus for the incoming administration. During his campaign, candidate Trump repeatedly pledged to “get rid of” Dodd-Frank, the set of sweeping financial services reforms passed in the wake of the 2008-9 financial crisis without a single House Republican vote and only three Senate Republicans supporting it (Senators Scott Brown of Massachusetts, and Olympia J. Snowe and Susan Collins of Maine).
Title IV the Dodd-Frank Act mandated that many previously unregistered advisers to private funds (such as hedge funds and private equity funds, but not venture capital funds) register with the SEC, making them subject to its oversight and enforcement jurisdiction.
In 2012, after the SEC’s Office of Compliance Inspections and Examinations launched a Presence Exam Initiative, examining more than 150 private equity firms, the SEC very publicly intensified enforcement activity over fund expenses, expense allocation, undisclosed fees, conflicts of interest, and issues related to the marketing and valuation of private equity funds. This left many private equity funds, particularly those in the middle market, to view themselves as having been unwittingly swept up in an impulse to over-regulate. In a July 2015 article in The Hill marking the 5-year anniversary of Dodd-Frank, the Association for Corporate Growth’s President, Gary LaBranche wrote:
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… 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 compliance1.
Another cornerstone of Dodd-Frank that has impacted private equity is the “Volker Rule.” Among its restrictions, the rule restricts banks and their affiliates from investing in and sponsoring private equity funds. Notwithstanding his opposition to Dodd-Frank, when asked about the rule during the campaign, Trump was noncommittal2.
House Financial Services Chairman Jeb Hensarling introduced legislation earlier this year that could become the foundation of a body of financial services deregulation moving through Congress in early 20173. Hensarling’s proposals, referred to as the “Choice Act,” include repealing the Volker Rule and lifting the threshold for bank regulation by the Consumer Financial Protection Bureau from $10 billion in assets to $50 billion4. The Volker Rule is blamed (rightly or wrongly) for hurting institutional fundraising by virtue of its restricting investment capital from banks. The Volker Rule is also widely credited with leading to the significant growth of the secondaries market after banks were forced to divest their “higher risk” investments. Many fund managers point to these regulatory changes as having had a negative impact overall on general lending activities among banks, leading to a decline in loan origination for buyouts and the corresponding rise of unregulated institutional investors lending via private markets funds and business development companies5.
In light of the above, it is reasonable to expect a roll-back of Dodd-Frank, or at least portions of it, though timing, and the fate of some of its more controversial aspects remain unknown.
Deal-makers in the private equity industry will be keeping an eye on the direction of antitrust enforcement under the new administration.
Under President Obama, antitrust review and enforcement was widely regarded as more aggressive than in prior administrations, as evidenced by an increasing willingness by regulators to challenge transactions that fell below filing thresholds of the Hart-Scott-Rodino Antitrust Improvements Act of 1976.
While Republican administrations are generally viewed as less aggressive in their enforcement posture, the Trump administration’s populist orientation could mean a more idiosyncratic antitrust posture. Citing AT&T’s bid to acquire Time Warner as an “example of the power structure I’m fighting,” Trump famously pledged during his campaign that he would seek to block the deal6. Moreover, if Trump makes good on pledges to clamp down on global trade, U.S. companies could be forced to find M&A opportunities at home, leading them to buy their domestic competitors, and potentially complicating competition regulation.
For more information on the antitrust implications of a Trump presidency, please see our partners’ Logan Breed’s and Janet McDavid’s article in Concurrences here.
National Security Review
The incoming Trump administration’s approach to foreign direct investment (“FDI”) in the United States and to national security reviews conducted by the Committee on Foreign Investment in the United States (“CFIUS”) is difficult to predict, but private equity investors would be well advised to keep an eye on developments in this area in the coming months. CFIUS is an inter-agency committee with the power to review the national security implications of transactions that could result in control of a U.S. business by a foreign person. CFIUS member agencies include the Departments of Treasury, Justice, Homeland Security, Commerce, Defense, State, and Energy, as well as the White House Offices of the U.S. Trade Representative and Science & Technology Policy. Therefore, the individuals selected to head these agencies may be the best early indication of the direction of CFIUS reviews under a Trump presidency.
Mr. Trump has criticized certain foreign investments in the United States, but his trade-related critiques have focused largely on U.S. free trade agreements and the loss of U.S. manufacturing jobs to foreign countries. Nonetheless, according to CNN, a Trump transition team draft memorandum outlining Mr. Trump’s trade policy for the first 200 days of his presidency indicates that Mr. Trump would mandate that CFIUS reviews be expanded to consider food security and reciprocity by foreign countries in their treatment of U.S. investments abroad.
Members of Congress previously have made similar proposals related to food security, including in connection with Chinese acquisitions of pork producer Smithfield Foods, Inc. and the U.S. subsidiaries of Swiss agribusiness Syngenta AG. In a September 15, 2016 letter, members of Congress, noting the upcoming presidential transition, called for the U.S. General Accountability Office ("GAO") to examine whether CFIUS’s regulatory and statutory powers “have effectively kept pace with the growing scope of foreign acquisitions in strategically important sectors in the U.S.” and to consider whether CFIUS should (i) use a net economic benefit test in its reviews of foreign investments and (ii) mandate reviews of Chinese government-backed investments. The GAO agreed to conduct the review. Last month the U.S.-China Economic and Security Review Commission, created by Congress in 2000, advocated outright barring Chinese state-owned enterprises from acquiring or otherwise gaining control of U.S. companies.
Under existing law, CFIUS reviews are focused on threats to U.S. national security. “National security” is not a defined term under the relevant regulations and statute, so even without regulatory or statutory changes, the Trump administration could seek to expand the scope of CFIUS’s reviews by interpreting “national security” to include food security and reciprocity in cross-border investments. Chinese media reports and our discussions with Chinese investors suggest that, at least in the short term, some Chinese investors might be cautious about certain investments in the United States until they better understand the Trump administration’s likely approach to FDI in the United States.
For more information on the incoming administration’s approach to FDI and potential CFIUS changes, please see our most recent information here.
It remains too early still to predict the precise contours of Trump’s policy agenda, and because of that, the impact he will have on private equity and deal-making generally. Nonetheless, changes are coming, many potentially profound. We will continue to monitor these developments closely and inform you of their potential impacts.
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