Thursday, April 4, 2013

Goldman Sachs Uses JOBS Act to Sidestep Volcker Rule


Evan Weinberger at Law360 is reporting that Goldman Sachs may have found a way around the Volcker Rule--the ban on proprietary trading by banks, which also prohibits sponsoring hedge funds and private equity funds--by using another controversial regulatory measure, the 2012 JOBS Act (of which we have spoken before):
By setting up an independent business development company in which it will hold a minority stake and limited leverage exposures, Goldman will be able to engage in at least limited proprietary trading. And because the firm will be small enough to qualify for as an emerging growth company under the 2012 Jumpstart Our Business Startups Act, the New York-based bank's new entity will also be freed from other regulatory requirements.
The basic idea is that Goldman will set up a business development company (BDC) that invests in other companies, especially small privately-owned companies.  BDCs have special tax status and are required to pay out most of their annual earnings in dividends to investors.  Under the JOBS Act, if a BDC is under a certain size (qualifies as an "emerging growth company"), it could be exempt from certain securities regulations.  For example, exemptions from certain sections of the Sarbanes-Oxley Act will result in more lenient reporting requirements for the company.

On the other hand, Goldman could sell this entity as a private equity fund it might otherwise be prohibited from sponsoring under the Volcker Rule.  Goldman's BDC will be called "Goldman Sachs Liberty Harbor Capital, LLC", and has already filed a preliminary registration document with the SEC.

The registration document itself is very interesting.  For example, the company will be 'externally managed' by Goldman Sachs Asset Management (GSAM), but that management appears to include a wide variety of services:
We expect to benefit from GSAM’s control, operational, administrative and support infrastructure, which we believe is one of the best in the financial services industry. Our risk monitoring will be provided by GSAM’s global risk management team, the same team that monitors risk for all of GSAM. We will utilize GSAM’s proprietary information technology systems, which we believe enhances our ongoing monitoring of our portfolio, among other things. Finally, we will be served by GSAM’s legal and compliance teams, which bring a wealth of experience gleaned over many years of support to GSAM.
However, Goldman Sachs itself will not be a majority investor.  The filing also notes that the company intends to leverage its investments as much as 200%.  This could, therefore, be seen as a way for Goldman Sachs to offer a private equity fund to investors in a format that would be compatible with the Volcker Rule.

It is unclear at this point if regulators will allow this registration to move forward--or if the Volcker rule, when finalized, will negate this possibility--but if it does, it may be a remarkable example of one regulation effectively (and unintentionally) nullifying another.

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