The SEC proposed extensive new regulation of private fund advisers under the Advisers Act. The SEC stated that it recognizes the important role private funds and their advisers play in the financial markets and that the purpose of the amendments - as outlined in the SEC rule proposal and fact sheet - is to expand the regulation of private fund advisers.
Proposed New Rules and Amendments
The proposed new rules and amendments would require the following:
- Quarterly Statement Rule. The proposal would require investment advisers to distribute quarterly statements to private fund investors, including information related to (i) fees and expenses, (ii) compensation to the adviser or its related persons, and (iii) fund performance. There would be different requirements for liquid funds versus illiquid funds.
- Private Fund Audit Rule. The proposal would require financial statement audits (i) at least annually, or (ii) upon liquidation and, in each case, delivered to private fund investors promptly after completion.
- Adviser-Led Secondaries Rule. Private fund advisers would be required to receive independent fairness opinions related to adviser-led secondary transactions. This requirement would act as a conflicts-of-interest check.
- Prohibited Activities Rule.The proposal would prohibit (i) charging certain fees and expenses to a private fund or its portfolio investments, such as fees for unperformed services or fees associated with the examination or the investigation of the adviser, (ii) seeking reimbursement, indemnification, exculpation or limitation of certain adviser liabilities, (iii) reducing potential clawbacks for taxes, (iv) charging fees or expenses related to portfolio investment on a non-pro rata basis, and (v) receiving an extension of credit from a private find client.
- Preferential Treatment Rule (Regulation of Side Letters). Side letters (i) could not provide preferential terms to certain investors related to redemptions from the fund or transparency, and (ii) other preferential treatment would be subject to a disclosure requirement.
- Books and Records Rule Amendments. The amendments to the books and records rule would help increase the SEC's ability to determine whether an adviser has complied with the proposals.
- Compliance Rule Amendments. The amendments to the compliance rule under the Advisers Act would require all registered advisers to document their annual reviews.
Comments on the proposal will remain open for 60 days following publication of the proposing release on the SEC's website, or for 30 days following publication in the Federal Register - whichever period is longer.
Commissioner Statements
SEC Chair Gary Gensler supported the proposed requirements, stating that "it would help investors in private funds on the one hand, and companies raising capital from these funds on the other." He also noted that the private industry currently has approximately $18 trillion in gross assets.
SEC Commissioner Caroline A. Crenshaw supported the proposal, explaining how it would "help private fund investors better assess the adviser's performance and decide whether to remain invested in a particular private fund, how to invest other assets, and whether to invest in private funds managed by the adviser in the future."
SEC Commissioner Hester M. Peirce opposed the proposal, stating that "[the proposal] represents a sea change" warning that " . . . these changes represent a meaningful recasting of the SEC's mission." She cautioned that the proposal (i) raises questions on the rationale for dividing retail from accredited investors, (ii) would divert Examinations and Enforcement resources away from the mission of retail investor protection, and (iii) could "hinder capital formation."
Commentary
This proposal may be viewed as a point of inflection for the private funds industry. Private funds are important to the capital markets with AUM at north of $18 trillion and continuing to grow. Investors include not only significant institutions, but every major pension plan. Private wealth, from high-net-worth individuals to family offices, is attracted to the management and returns. Moreover, private funds' roles are not limited to vehicles for passive investment - private funds can lend, extend credit, change the direction of public companies, and influence policies in climate change or ESG.
The significance of private funds is, for better or worse, recognized by the SEC in this proposal. While more regulation is generally not welcomed, the practical takeaway is that private funds have attracted the SEC's focus and that focus is not likely to diminish. Advisers must therefore focus on the specifics of each of the proposed new requirements, consider which are reasonable, and which will impose burdens beyond their expected benefits.
Primary Sources
- SEC Press Release: SEC Proposes to Enhance Private Fund Investor Protection
- SEC-Proposed Rule: Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews
- SEC Fact Sheet - Private Fund Proposed Reforms
- SEC Chair Gary Gensler: Statement on Private Fund Advisers Proposal
- SEC Commissioner Caroline A. Crenshaw: Private Fund Advisers Proposal - Statement in Support of Accountability Enhancing Updates
- SEC Commissioner Hester M. Peirce: Statement on Proposed Private Fund Advisers; Documentation of Investment Adviser Compliance Reviews Rulemaking
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