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A revived effort by the federal government to regulate hedge funds threatens to drive venture capital investors into the same herd, but VCs — who dodged a similar SEC bullet once four years ago — seem unconcerned.
The Hedge Fund Transparency Act, filed in late January, would require all alternative-investment entities with $50 million or more under management to report to the Securities and Exchange Commission the value of their portfolio companies and disclose the identities of their limited-partner investors.
Critics say the prospect of disclosure would hurt VC fundraising, and public valuations could harm the prospects of early-stage startups.
Staffers in the offices of co-sponsors Sen. Chuck Grassley (R-Iowa) and Sen. Carl Levin (D-Michigan) said they never intended to out limited partners, and they are open to changing the bill in response to venture capital concerns. However, a Levin aide said there is no intention to give VC’s a break on reporting valuations for their portfolio assets.
Several Boston-area VCs said they’re not worried, noting that the legislation is still at an early stage. However, the momentum behind new regulation leads some watchers to believe VCs should be concerned.
“The thing that I think is upsetting is the asset-valuation report,” said attorney William Kelly, a partner at Nixon Peabody LLP who represents alternative investment funds. “People want to just let the legislation pass as written and then just hope the SEC is reasonable.”
The law as written leaves regulation up to the SEC, which could require VCs to pin a value on each portfolio company. A low valuation could hurt an early-stage company’s ability to attract customers, Kelly said.
“Some of it looks like it could have real impact,” said Carl Stjernfeldt, general partner at Waltham-based Castile Ventures. But the bill is only the beginning of a long process, he added. “I think the definition of ‘investment firms’ will be a topic of many debates,” he said.
In his Senate floor speech at the introduction of the bill on Jan. 29, Levin effectively threw up his hands at the prospect of trying to define differences between hedge funds and VCs, calling it a “futile exercise.” Exemption from public reporting allowed some hedge fund managers to continue attracting investment dollars, even as their funds plunged last year, threatening investment banks.
“The idea of putting us in the same category as hedge funds, it’s truly apples and oranges,” said National Venture Capital Association president Mark Heesen. “There aren’t that many hedge funds under $1 billion.”
In February 2006, after high-profile cases of investor fraud — but long before the news about Bernard Madoff’s alleged massive fraud broke — the SEC attempted to require hedge fund managers to register as investment advisers. A federal appeals court vacated that decision a few months later, saying the SEC had gone beyond its authority. Lawmakers proposed new legislation at the time, but it was never enacted.
“Grassley introduced this legislation in 2006 and it never even got a hearing,” Kelly said.
But in the midst of an economic crisis, hedge fund regulation has gained momentum its second time around. “Something is clearly going to happen,” he said. “Grassley and Levin are the first out of the gate, but they’re not the most powerful in terms of banking legislation. This is clearly not the last word.”
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