Private Equity And The New Trump Administration: Your Top Ten Questions Answered
The election of President Trump contained more than a few positive signs for Private Equity (PE) firms. Promises of a lower corporate tax environment, a ten-percent tax holiday for funds parked overseas, large infrastructure investments, and deregulation could portend increasing portfolio returns. Yet on the other side of the scale are troubling regulatory concerns, what with President Trump also promising restrictions on international investment in the United States (which could complicate investment and exit strategies, including through hard-nosed national security reviews by the Committee on Foreign Investment in the United States (CFIUS), withdrawing from NAFTA (thereby disrupting the trade relationship with one of the three largest U.S. trading partners), and maybe even welcoming an international trade war, particularly with China (which could complicate cross-border supply chains and raise input costs).
Further complicating the picture, the U.S. government over the last decade has emphasized regulatory initiatives that directly and indirectly target PE firms and their portfolio companies. Generally these enforcement actions have involved regulations with an international hook, including: (1) the Foreign Corrupt Practices Act (an antibribery statute barring the payment of bribes to non-U.S. government officials); (2) economic sanctions administered by the Office of Foreign Assets Control (OFAC) (which restrict dealings with targeted foreign countries, governments, and persons who have taken actions against U.S. national and foreign policy interests); (3) export controls (with the Export Administration Regulations (EAR) and the International Traffic in Arms Regulations (ITAR) restricting the export of controlled U.S. goods, information, software, and technology); (4) anti-money laundering (AML)restrictions; and (5) international antitrust actions, especially for collusion and price fixing.
In each of these areas, civil and criminal penalties, both at the corporate and individual level, have been used as a massive deterrence club. This enforcement focus has sharply increased regulatory risks for PE firms that raise money internationally or that own portfolio companies that operate internationally or that export or sell to foreign countries. With the SEC using its Dodd-Frank powers to target PE firms with enforcement attention, and the U.S. government recently assessing the fourth-largest FCPA penalty of all time ($412 million) against PE firm Och-Ziff, PE firms have never faced a riskier regulatory environment.
The confluence of the campaign rhetoric, the uncertain enforcement environment, and the international flavor of many PE firm's fundraising, investments, and operations, raise numerous regulatory questions at the dawn of the new administration.
Will the Dodd-Frank Act and its compliance requirements targeting PE firms be repealed? Will the potential trade war being telegraphed by the administration become a reality? Will NAFTA be repealed, upsetting the international supply chains of many PE portfolio companies? Will the enforcement attention on PE firms continue? Does the Och-Ziff FCPA action, which included a multi-million penalty on the head of the PE firm, represent a new trend of personal liability for PE firm senior management? And is there anything that PE firms can do to cope with this perilous regulatory environment? To help navigate this uncertain future, this client alert presents the "top ten" regulatory and trade questions every PE firm company with international interests or that raises investment funds internationally should be considering. This client alert is part of a series of "top ten" articles on the future of key international trade and regulatory issues expected to change under the Trump administration. Previously issued client alerts discuss the future of NAFTA,1 Customs and Border Protection,2 and international trade litigation under the Trump Administration (including antidumping and countervailing duty actions),3 the future of the CFIUS review process,4 and likely developments impacting white collar enforcement.5 Future client alerts will deal comprehensively with all international trade and regulatory areas where significant change could occur under the new administration.
THE TOP TEN PE REGULATORY QUESTIONS ANSWERED (OR, WILL PRESIDENT TRUMP MAKE PE RETURNS GREAT AGAIN?)
1. "What has President Trump promised?"
During the campaign, President Trump's populist instincts appeared to be aligned against PE firms. President Trump's frequent criticisms of U.S. manufacturers moving jobs overseas implicitly targeted the decisions of PE firms, which often take a global strategy to allocating capital and sourcing manufacturing to maximize investor returns. Mr. Trump's criticisms of PE powerhouse Goldman Sachs, in particular, were frequent and seemed to telegraph hostility towards the industry.
In this case, however, elected actions likely trump election rhetoric, as the Trump transition team and high-level nominations are heavily drawn from the PE world - including from Goldman Sachs. Chief strategist Stephen Bannon, Secretary of the Treasury nominee Steve Mnuchin, and National Economic Council Director Gary Cohn all previously worked at Goldman Sachs, while SEC Chair nominee Jay Clayton was a partner at Sullivan & Cromwell, where he represented Goldman Sachs. Other senior and transition advisors have ties to Goldman Sachs as well. Additional Cabinet nominees, such as Department of Commerce nominee Wilbur Ross (hailing from PE firm WL Ross & Co.) and economic advisory council member Stephen Feinberg (former CEO of Cerberus Capital Management) also have strong PE roots.
This is hardly a murderer's row of populist advisors looking to crack down on PE firms. Indeed, in at least one way - the fate of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) - it appears that momentum is building in the new Republican Congress to give Mr. Trump a victory in substantially curtailing or even repealing the Act, which is a course Mr. Trump recently endorsed. Since the Dodd-Frank Act subjects many PE firms to strict SEC oversight and compliance requirements, curtailing or repealing the Act would be a welcome development to many PE firms, which have chafed at the aggressive application of SEC regulatory requirements.
2. "What is the landscape for international regulatory enforcement? Is it likely these trends will continue under the new administration?"
There have been many trends related to the regulation of exports and international conduct that are of concern both with regard to the operation of PE portfolio companies and at PE firm's own operations. Chief among these are the following:
Emphasis on International Regulations. The largest penalties in recent enforcement actions (outside of the crackdown on sub-prime mortgage abuses) have involved U.S. regulations governing exports and international conduct. In particular, the U.S. government has emphasized the areas of international antitrust (particularly collusion and price fixing), export controls, OFAC economic sanctions, anticorruption (FCPA), and AML for enforcement attention, imposing tens of billions of dollars of penalties under these regulatory regimes. Because PE firms often invest in companies that operate in, sell into, and trade with foreign countries, this trend of increasing penalties sharply increases the risk profile of the investment portfolios of most PE firms. Individual Liability. The U.S. government, including through the issuance of the "Yates Memorandum" ( discussed here6), has emphasized individual liability, believing that nothing has a greater deterrent effect than the prospect of hefty fines or jail time for senior executives. The imposition of a multi-million dollar fine and other sanctions directly on senior managers at PE firm Och-Ziff, including the head of the company, illustrates that the U.S. government easily can apply this focus to PE firms. Increasing Use of Criminal Penalties. The U.S. Government has increasingly been willing to use either the threat, or the actual imposition, of criminal proceedings as enforcement tools. This combines with another trend discussed below, which is to use penalties - including criminal penalties against individuals - to send a compliance message. Even where civil penalties are the result, the threat of criminal penalties can be used as leverage to extract a larger civil penalty. Liability Based Upon Control. Many PE firms have (falsely) taken comfort in the idea that operating models emphasizing the role of the PE firm as an allocator of capital and management expertise, while leaving the active management of the companies to senior portfolio company managers, insulates them from direct liability for compliance lapses at portfolio companies. SEC actions, however, have introduced the concept of liability for failure to maintain adequate internal controls and failure to notice indications of fraud or regulatory lapses. The DOJ, as well, has no problem going after owners of third-tier subsidiaries, joint ventures, and other parties that control an entity, even if they do not directly participate in the management of the company. Similar logic applies equally to PE firms. The U.S. government believes ownership confers compliance responsibilities, with failures being punishable by hefty fines. The hands-off approach to compliance that is the rule at many PE firms no longer is tenable (if it ever was). 3. "Are there regulatory areas of special concern for PE firms?"
The U.S. government has made PE firms an enforcement and compliance target in recent years. These efforts include the SEC sending the largest PE firms letters of inquiry into their compliance practices, which some link to the September of 2016 SEC announcement that Och-Ziff Capital Management Group would pay approximately $200 million to settle SEC charges of...
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