Can private equity managers minimize Dodd-Frank compliance costs?
It’s a law of physics and politics at the same time: every action results in an equal and opposite reaction. In the case of the 2008 financial crisis, the reaction came in the form of the Dodd–Frank Wall Street Reform and Consumer Protection Act, which was signed by President Obama on July 21, 2010. In an attempt to prevent financial institutions from taking an outsized role in the economy, Dodd-Frank brought a larger scope of these institutions under the umbrella of the Securities and Exchange Commission.
While much of the political attention has been focused on the large banks, private equity firms have also borne a significant burden from the new requirements brought about by Dodd-Frank. In particular, Dodd-Frank required private equity funds to comply with onerous reporting and document retention requirements. The list of transaction records, contractual interests, and communications which must now be retained is very long and quite detailed.
Significantly, retention and reporting on most of these records was never a requirement for private equity in the past. In the last several years, most private equity firms have created these systems from scratch, often at great expense. As these systems were created, the private equity industry had to learn quite a bit about how their transactions are interconnected (which was most of the point of Dodd-Frank).
Even more, private equity firms have learned about the technological systems which are required to collect, retain, and organize all of that data. Those systems come with a cost, one which can be quite significant depending on how firms decide to structure their compliance regime. A recent study showed a huge variation in Dodd-Frank compliance costs for private equity firms, with a median cost around $187,000 per year.
Much of the cost of compliance comes on the front end as companies set up the systems and processes to collect and retain all the necessary information. The study concluded that Dodd-Frank serves as a barrier to entry for new private equity firms, as well as a competitive threat to smaller private equity firms which lack the I.T. prowess of their larger competitors.
It’s tempting to say that the solution to this issue is to roll back Dodd-Frank – its reporting requirements clearly create a burden on private equity. Yet the political spin on this issue misses the context of how financial reporting systems are created and sustained.
The enactment of Dodd-Frank happened to coincide with a technological revolution in data storage and analytics. Where financial companies once had to buy all the equipment and software for compliance themselves, they can now run all of their compliance operations in the cloud using powerful software-as-a-service applications which parse all the necessary information automatically. As those systems become more sophisticated and less tied to expensive infrastructure, the cost of Dodd-Frank compliance will sink ever lower.
That’s not to minimize the administrative burden of the regulations, which remains significant. Yet technology increasingly provides a work around of sorts, in the form of smarter systems which can perform more of the required Dodd-Frank reporting in the cloud at a fraction of what it once cost.
Want to lower your private equity firm’s Dodd-Frank reporting costs? ECHO can help.