Over-regulation hampers investment in Main Street

Small private equity funds in particular do not create systemic risk because we don’t trade synthetic financial instruments. We also do not speculate on currencies or commodities, and we don’t put the retirement of retail investors at risk.  We invest directly in small businesses, the backbone of our economy and the growth engine for job creation. Private equity firms do well, quite simply, when the economy is humming and economic growth is at its highest.

As I told Congress, I support a strong regulatory structure within which to operate.  A clear, thoughtfully developed body of regulation is essential to the consistency, predictability and smooth operation of the securities industry.  But regulation should be appropriate to the context to which it is applied, and not redundant or in conflict with other regulations.

{mosads}Congress was well-intentioned in writing the Dodd-Frank financial regulatory reform, signed into federal law by President Obama in 2010. The law brought significant financial regulation to the entirety of the financial industry, in hopes of heading off another economic crisis. However, some work needs to be done to reduce the cost of over-regulating, especially within the private equity industry. 

The total compliance costs of initially registering with the Securities and Exchange Commission (SEC) for my firm was approximately $100,000, and we estimate that we will spend more than $200,000 annually to comply. While for some larger firms this is an insignificant cost, for a medium sized firm such as ours that offers capital to small businesses, it is a significant expense, and one that comes directly out of our funds intended for investment into Main Street.

Some rules that came out of the Dodd-Frank Act are mostly inapplicable, and in some cases redundant, to many private equity firms. The hiring of a third party custodian to hold onto untradeable securities is one such SEC rule.  Because we invest in privately held securities which are not readily marketable or transferrable, this rule does not make sense for private equity funds.

Likewise, we are now required to retain and archive all e-mail messages, then review them to detect illegal activities such as insider trading.  Given that middle market private equity funds generally do not deal in or sell publicly-traded securities, such e-mail screening is a purely regulatory exercise with no benefit to investors or the public good.

Of specific significance to small funds is the threat of double regulation.  Funds organized as Small Business Investment Companies (SBICs) are regulated by the U.S. Small Business Administration (SBA).  The Small Business Investment Act of 1958 effectively created the market for small business investing with the establishment of the SBIC program.  Since the program’s creation, the SBA has established a sound regulatory structure designed for private equity investing with a robust set of rules and safeguards for our industry.

Because of a technical glitch in the Dodd-Frank language, private funds that manage both SBICs and non-SBICs can be exposed to double regulation by the SEC and the SBA.  SBICs could also face regulation by state regulators, as the Dodd-Frank Act doesn’t explicitly exclude additional regulation by the states.  The cost of regulation by two federal agencies and a state regulator hampers our ability to invest capital to help well-established small businesses drive economic growth and create jobs.

Speaking of jobs, companies that received financing from my firm have generated upwards of 4,000 jobs for hard-working Americans.  A 2012 study by Pepperdine University indicates that private-equity-backed businesses created 250 percent more jobs than businesses that have not been backed by private equity firms.

Congress can act immediately to remove the over-regulation on small private equity funds by passing the bipartisan Small Business Capital Access and Job Preservation Act, sponsored by Reps. Robert Hurt (R-Va.) VA-5) and Jim Himes (D-Conn.). After several years adjusting to the regulations imposed by the Dodd-Frank Act, we’ve had some time to see what is right and what is wrong with its rules.  It is now time to clean up the parts we can all agree should not apply to certain financial firms, so that more investment capital can get to work for Main Street and our economy.

Reich is president of Ironwood Capital in Avon, Connecticut. Ironwood Capital is a member of the Small Business Investor Alliance, the trade association of lower middle market private equity funds that provide capital to small and medium sized businesses nationwide.