SEC Proposes Significant Changes for Private Funds

  • Private equity
  • 4/6/2022

Author: Johnny Minassian In a series of proposed rules released during the first quarter of 2022 so far, the Securities and Exchange Commission (SEC) has taken steps...

Author: Johnny Minassian

In a series of proposed rules released during the first quarter of 2022 so far, the Securities and Exchange Commission (SEC) has taken steps towards expanded disclosures and regulatory requirements impacting private fund advisers and the funds they manage.  The proposed rules touch upon several aspects of operations, reporting, and compliance of registered advisers and potentially would increase cost of conducting business in this industry with the upside of providing investor protection and lowering of systemic and counterparty risk, in this case, associated with private funds.  In this article we highlight what we think are some of most impactful to advisers:

Quarterly statements: a large proportion of private advisers provide monthly or quarterly reporting to their investors, however the February 9th SEC proposal requires quarterly granular disclosures related to fund costs, adviser or adviser related party fees (by type), and various fund performance measures (including from inception performance measures).  The proposed rules specify different performance disclosures by type of fund (open vs closed end).

Fund Audits: most advisers to private funds obtain an audit of the fund’s financial statements to comply with either custody or partnership agreement provisions; however, the proposed regulations provide for subtle changes that will alter current manner of investor reporting in meaningful ways.  The proposal requires the prompt distribution of audited financials to investors upon their completion and requires the PCAOB registered auditor to notify the SEC upon issuance of the auditor opinion (proposal also suggests a mechanism for auditors to inform the SEC of their engagement, disengagement, or termination).

Advisor Led Secondary Transactions: the proposed rules would require a secondary transaction be supported by a fairness opinion provided by an independent entity (SEC proposes full disclosure of advisor relationship with the entity providing the opinion) to substantiate the value of the transaction.  Secondary transactions occur when the advisor of a private fund facilitates the sale and/or purchase of a limited partner interest to/from one fund managed by the adviser with another limited partner interest also managed by the adviser.

Prohibited Activities/Preferential Treatment:  the SEC proposes the prohibition of transactions that invariably could create conflicts of interest or costs that would be deemed to be outside of industry best practices.  Highlights of such activities include borrowing from an investor, charging of fees in advance of performing the service to the fund, seeking expense reimbursements that would be expected to be borne by the adviser, charging of expenses related to a private investment on a non-pro rata basis amongst the various pools managed by the adviser that own the same investment.  The SEC also proposes to prohibit preferential treatment around information, terms or time, to certain investors compared to others in the same fund.

Record-Keeping: associated with the above context, the SEC takes the next logical set of proposing robust set of rules to evidence advisers’ adherence to these rules.

The proposed set of rules elevate what are known as best practices among both registered and unregistered advisers into common institutional practice with the expected result of investor protection regardless of the accreditation and qualification status of the typical investor in a private fund.

In another set of proposed rules by the Securities and Exchange Commission (SEC) to form PF (if passed) will make private funds and their advisors’ activities more transparent to interested audiences.  Form PF was originally adopted as a reporting mechanism in 2011 as a partial response to events occurring during the financial crisis in the United States and globally approximately from 2007 through 2009.  The January 26th proposal seeks to update form PF disclosures, shortens the reporting time of certain event driven disclosures, and modifies adviser reporting thresholds.

Large Private Equity Adviser Definition: under the SEC proposal, large private equity adviser definition would decrease from $2B under management to $1.5Billion, capturing more private fund advisers.

One Business Day: SEC proposes that advisers to large hedge funds report within a day events such as significant losses experienced in a fund (20% over 10 days), significant margin defaults, prime broker terminations, and material fund redemptions (50%).

Large Private Equity Adviser Reporting: with the newly proposed reporting thresholds, large private equity advisers would report fund strategies, leverage use, portfolio company restructurings, adviser led secondary transactions, and similar activity and adviser led secondary transactions.

We expect the regulatory push towards disclosure and transparency of Private Funds and their advisors’ operations to continue. 

This blog contains general information and does not constitute the rendering of legal, accounting, investment, tax, or other professional services. Consult with your advisors regarding the applicability of this content to your specific circumstances.

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