Study Finds That Dodd-Frank Title IV Pushes Out Smaller Private Fund Advisers (with Lofchie Comment)

In a study titled "What Drives Dodd-Frank Act Compliance Cost for Private Funds?" University of St. Thomas School of Law Associate Professor Wulf A. Kaal assessed the extent to which Dodd-Frank compliance costs are forcing smaller private investment fund advisers out of the market. Professor Kaal's study found that compliance costs have a strong fixed cost element; i.e., the advisers to smaller funds pay more in compliance costs proportionately than the advisers to larger funds must pay. According to Professor Kaal, the findings of the study suggest that (i) the Dodd-Frank compliance costs that are imposed on investment advisers create barriers to entry for smaller private fund advisers, (ii) smaller private fund advisers may be forced out of the market or compelled to consolidate with other private fund advisers and (iii) the consolidation of the private fund industry is likely to increase the number of larger private fund advisers.

Lofchie Comment: Professor Kaal's study of compliance costs is both significant and completely unsurprising. Imposing a massive regulatory program hurts small firms more than large ones and makes smaller firms uncompetitive. Dodd-Frank compliance costs do not affect smaller investment advisers alone: it has been reported that small banks, too, are hurt, and that the number of futures commission merchants has materially declined since the compliance costs were introduced. It is possible to argue that the economy and the financial system truly are better served when smaller firms are driven out of business or forced to consolidate. Legislators and regulators could make the case plausibly that small firms constitute a public threat insofar as they cannot afford to maintain appropriate systems or to hire sufficiently skilled personnel. After all, who would want to bank with an institution that had only $1 million dollars in assets, or hire an investment adviser who only managed $1,000 dollars? However, neither legislators nor regulators are willing to make these arguments in response to claims that they are damaging smaller businesses. Instead, many assert that they can determine the extent to which Dodd-Frank has made the financial system "safer," but somehow find it impossible to discern any connection between high regulatory costs and the shrinking number of small institutions. How can their assertion be advanced if that connection cannot be demonstrated?

Related news: FDIC Vice Chair Urges Lawmakers to Adopt Regulatory Relief Criteria for Community Banks (with Lofchie Comment) (August 4, 2015); FRB and FDIC Provide Joint Feedback on Non-Banks' Resolution Plans (July 28, 2015).