2010 - The Year of the Regulator?

Mark Mifsud, Lisa Cawley and Stephanie Biggs at Kirkland & Ellis International LLP


Regulation promises to be the hot topic of 2010, with both EU and US lawmakers looking to bring private equity fund managers within the regulatory net.

"We have learnt the lesson from the crisis that in the financial area everything must be regulated and supervised."
-- Jean-Paul Gauzes MEP, Rapporteur, Alternative Investment Fund Managers Directive

As private investment vehicles for primarily institutional investors, private equity funds have traditionally operated in a lightly regulated, or even unregulated, environment. But in the wake of global financial meltdown, M. Gauzes is by no means alone in his view that private equity firms must be subject to regulation. The key question is not if, but how and when, private equity fund managers will be regulated.

This question is easier to answer in relation to the US, where the proposal, in broad terms, is to bring private equity fund managers within the existing Securities and Exchange Commission (SEC) investment adviser registration regime by removing certain exemptions. Although the details are not final, the changes will be relatively straightforward to implement, and may well be enacted in 2010 and brought into force during 2011.

In the EU, the position is much less clear. The debate surrounding the proposed EU Alternative Investment Fund Managers Directive (AIFMD) has become highly politicised, with different political groupings and different member states holding widely divergent views. When the AIFMD was proposed in April 2009, the goal was to enact the proposal at EU level by the year end, with the new regime coming into force across the EU in 2011. This has turned out to be somewhat optimistic. At the beginning of December, the Swedish presidency's attempts to broker a deal between the various member states collapsed in disagreement, and the Swedish compromise proposals were, in any case, substantially different from the amendments proposed by M. Gauzes in his draft report to the European Parliament.

It is now for the Spanish presidency to take the negotiations forward at inter-governmental level, and it remains to be seen whether agreement can be reached by, and with, the European Parliament. Certain key proposals appear to be largely agreed between all parties, and are likely to be incorporated into the final legislation in some form, but it is difficult to predict exactly what the final position will be or when agreement will be reached. Once the proposals have been agreed at EU level, there will a transposition period for implementation at national level. The transposition period is usually around 18 months, so it is now unlikely that the new regulatory regime will be in force before 2012.

This article looks at the different approaches proposed on each side of the Atlantic, and considers the impact of the proposals for private equity firms operating on a global basis. In particular, it examines:

  • The current regulatory regimes in the US, the EU and the UK.
  • The new proposals in the US and the EU.
  • The cross-border issues, conflicts and tensions that may arise with the new regulatory regimes.



The US Investment Advisers Act of 1940 (IAA) regulates the activities of persons who, for compensation, advise others about investing in, purchasing or selling securities, and requires them either to register with the SEC or to have an exemption from registration. In addition, almost all US states regulate non-SEC registered investment advisers with a place of business in the state.

Currently, many private equity fund managers rely on an exemption from registration under the IAA, on the basis that they have fewer than 15 clients (with each fund usually counting as a single client). Firms that manage large numbers of funds, firms with complex fund structures involving parallel funds or feeder funds or firms affiliated with large financial services companies may not meet this test and so will already be SEC registered. However, most private equity fund managers are able to take advantage of this exemption, with the result that the US private equity industry is largely unregulated.

Private equity funds themselves will generally be exempt from SEC registration under the US Investment Company Act of 1940 (ICA) on the basis that they qualify as private funds. A private fund means a fund that is not required to register as an investment company under the ICA because either:

  • All investors are "qualified purchasers" (QPs). QPs are either:
    • individuals who own at least US$5 million (about EUR3.4 million) in investments;
    • companies that own at least US$25 million (about EUR17.1 million) in investments.

These funds are known as 3(c)(7) funds.

  • The fund is privately offered and there are no more than 100 investors. These funds are known as 3(c)(1) funds.

For non-US funds, only US investors are counted when applying these tests. In all cases, a fund is only exempt if it does not make a public offering of its securities.


At present, neither private equity funds nor private equity fund managers are subject to regulation under EU law.

The only fund product currently regulated on a pan-European basis is the Undertaking for Collective Investment in Transferable Securities (UCITS), a retail investment fund that may be marketed freely to consumers across the EU. As UCITS funds must invest primarily in listed securities, they are not suitable as private equity fund vehicles and private equity firms are not within the ambit of this regime.

Although there is no EU level regulation of funds other than UCITS, it is possible that private equity firms may provide regulated investment services under Directive 2004/39/EC on markets in financial instruments (MiFID), either as a result of the fund structure used or because services are provided on an ancillary basis to clients other than the fund itself, such as co-investors or portfolio companies. The primary example is where an EU-based private equity firm provides investment advisory or sub-advisory services to a non-EU based fund or fund manager (whether based in an offshore jurisdiction such as the Channel Islands or the Cayman Islands, or simply based in a non-EU jurisdiction such as the US). As a non-discretionary adviser, the private equity firm is unlikely to qualify for the MiFID fund manager exemption, and so may require authorisation as a MiFID firm.

However, national regulators within the EU have taken fundamentally different views on the application of MiFID to private equity. For example, the UK Financial Services Authority (FSA) has stated very clearly that it considers private equity advisory firms to be within the scope of MiFID, whereas the German Bundesanstalt fr Finanzdienstleistungsaufsicht (BaFin) has been equally clear in the contrary view. Therefore, although certain private equity firms will be regulated MiFID firms, it remains essentially true to say that private equity fund managers, as such, are not currently regulated at EU level.


One of the key exceptions to the assertion that private equity is an unregulated sector is the UK, where a substantial number of private equity firms are based. UK private equity firms, and fund managers operating out of London on a pan-European or global basis have been regulated by the FSA for a number of years.

The FSA regulates firms that carry on certain financial services activities, including:

  • Establishing, operating or winding up a collective investment scheme.
  • Managing investments.
  • Advising on investments.
  • Arranging deals.

Most private equity firms undertake some, if not all, of these activities, and so require FSA authorisation.

Once authorised, a private equity firm must comply with the FSA Handbook of Rules and Guidance (FSA Rules), which include high-level standards applicable to all authorised firms, detailed provisions governing the day-to-day operation of the firm's business and regulatory capital requirements.

In addition to statutory regulation, firms that are members of the British Private Equity and Venture Capital Association (BVCA) are also required to follow the Walker Guidelines for Disclosure and Transparency in Private Equity on a comply or explain basis. The guidelines require firms that invest in large UK companies to produce annual reports about themselves and about the companies in which they invest. These reports contain key information relevant to stakeholders such as employees and, for portfolio companies, are rather like the annual reports produced by quoted companies. Similar guidelines are also in effect in a number of other EU jurisdictions, such as Sweden and Finland.



Private equity firms with a place of business in the US, and non-US firms with significant commitments from US investors, are likely to be required to register with the SEC from 2011. The details are not yet final, but if the proposals go through as anticipated, the "fewer than 15 clients" exemption will effectively be abolished for firms with assets under management (AUM) of US$150 million (about EUR103 million) or more (although venture capital firms may continue to be exempted). Firms without a US office are likely to be required to register if they manage US$25 million or more of commitments from US investors and have AUM of US$150 million or more in total.

Under the proposed registration regime, private fund managers would be required to file confidential reports about their funds designed to monitor systemic risk, and could be subject to additional restrictions if the private funds were found by regulators to pose systemic risk.

The SEC registration process requires firms to complete an online form, Form ADV, which contains detailed information about the firm and its business, and is publicly available. The firm must also prepare a Form ADV, Part II disclosure document for investors, which is not currently publicly filed, containing information about matters such as:

  • Investment techniques.
  • Investment team and management biographies.
  • Code of ethics and proxy voting policy descriptions.
  • Conflicts of interest.

Form ADV must be updated annually, or in the event of material changes.

Once registered, a firm will be subject to conduct of business regulation covering, among other things:

  • Adoption, maintenance and testing of a detailed compliance programme.
  • Conflicts of interest.
  • Advertising and private placement memorandum (PPM) restrictions, particularly in relation to track record information.
  • Custody (the requirements are often satisfied by the preparation of US generally accepted accounting principles (GAAP) audited financials) and valuation.
  • Change of control.
  • Restrictions on carried interest (although 3(c)(7) funds and many 3(c)(1) funds are exempt from these restrictions).

The firm will also be subject to periodic inspections by the SEC, and may receive occasional unannounced inspections.


The EU proposals are still in a state of flux, but certain core aspects of the proposals seem relatively settled and unlikely to change. The AIFMD covers all funds that are not UCITS funds, and it is likely to apply to all EU-based fund managers, regardless of where the funds managed are established or domiciled. It pulls together elements of Directive 85/611/EEC on UCITS, as amended, MiFID and the existing capital adequacy framework, and adds additional requirements that are specific to alternative investment funds.

Firms that are within the scope of the AIFMD will be subject to:

  • Authorisation and regulation by their national regulator.
  • Conduct of business regulation on matters such as conflicts of interest, risk management and, increasingly likely, remuneration.
  • Organisational requirements relating to custody of assets (including a requirement to appoint a depositary), valuation of investments and delegation of functions.
  • Prudential regulation (that is, a regulatory capital requirement (although the proposals for the amount of regulatory capital to be held have ranged from EUR50,000 (about US$73,100) to EUR10 million (about US$14.6 million))).
  • Transparency requirements including increased regulatory reporting, additional disclosure to investors and detailed portfolio company reporting.

The other key aspect of the AIFMD is the marketing passport. Once a firm has been authorised in its own member state, it will be entitled to market EU-based private equity funds to professional investors across the EU without needing to comply with separate private placement regimes in each EU jurisdiction. For EU-based private equity firms, this should generally be a benefit. However, there are still some outstanding practical issues. For example, the definition of "professional investor" is relatively restrictive, so it may be more difficult to market to investors such as high net worth individuals. In addition, it is not yet clear on what basis non-EU funds may be marketed to EU investors, either by EU-based managers or by managers based in non-EU jurisdictions such as the US.


The credit crunch, and the financial crisis that followed, have brought to the fore one fundamental issue: how to ensure effective regulation of global industries and global institutions through national, or even international, regulation. These tensions can clearly be seen in the proposals for the regulation of private equity fund managers and the ensuing political debate. Legislators in both the EU and the US seem reluctant to accept that regulation, and regulators, in other jurisdictions will be as rigorous or effective as their own regimes.

This has resulted in regulatory proposals that are, in many ways, extra-territorial. It seems likely that many EU-based fund managers who invest wholly within the EU will be required to register with the US SEC simply because they take what, in private equity fund terms, are relatively small commitments from US institutional investors. Conversely, the original draft of the AIFMD would effectively prevent US fund managers from raising money from EU-based investors at all, although it now appears that this restriction will be substantially relaxed. There seems no prospect of mutual recognition, so firms with offices in both the EU and the US will, in all likelihood, be subject to both regulatory regimes.

There are, of course, some significant differences between the two sets of proposals, and the EU proposals clearly go further than anything proposed in the US. In particular, the lack of prudential regulation in non-EU jurisdictions causes EU legislators concern. Private equity fund managers may argue that regulatory capital requirements are, in any case, inappropriate to the private equity business model, but they are seen as a central plank of the EU regulatory system. The other major difference is the formalisation and pan-European application of portfolio company transparency and disclosure requirements, reflecting, perhaps, a more European perspective on workers' rights. There are also many instances where the detail of the two sets of requirements differs.

But in many ways, it is the similarities and not the differences that are striking; the core of the two regimes is much the same. Both sets of proposals will require private equity firms to register with the regulator, to provide detailed information about the firm and its business, and to be subject to conduct of business and organisational requirements that cover similar ground. This should provide some small comfort to firms who will have to operate under both sets of rules.

Mark Mifsud, Partner,

Mark is a private funds partner in the London office of Kirkland & Ellis International LLP. Mark advises private equity managers in relation to the structuring and establishment of private equity and real estate investment funds, secondaries, incentive schemes, carried interest arrangements and co-investment plans. Mark has extensive experience in a wide range of jurisdictions. He also advises on related matters and general corporate finance.

Lisa Cawley, Partner,

Lisa is a regulatory partner in the London office of Kirkland & Ellis International LLP. Lisa has extensive experience in financial regulation and corporate matters, including the establishment of new investment, banking and insurance businesses in the UK, the negotiation of regulatory approval for changes of control, the management of regulatory issues in connection with funds and the provision of investment, banking and insurance services on a cross-border basis.

Stephanie Biggs, Partner,

Stephanie is a partner in the private equity team in Kirkland's London office. Stephanie has wide-ranging experience in private equity fund formation, with particular expertise in regulatory and compliance issues affecting private equity firms. She also has extensive knowledge of corporate and partnership law, and has advised on matters ranging from the establishment of limited liability partnerships as vehicles for fund managers to complex share capital reorganisations for UK portfolio companies. Stephanie is a member of the BVCA Legal and Technical Committee.

Kirkland & Ellis International LLP Kirkland & Ellis has a 100-year history of providing exceptional service to clients around the world in complex corporate and tax restructuring, litigation, and intellectual property, and technology matters. The groundwork has been established for another century of superior legal work and client service. The Firm has offices in Chicago, London, Los Angeles, Munich, New York, Palo Alto, San Francisco, Shanghai and Washington, D.C.

© This article was first published in the PLC Cross-border Private Equity Handbook 2010 and is reproduced with the permission of the publisher, Practical Law Company.