- The SEC is expanding the criteria to be considered an accredited investor in private investment companies.
- With LIBOR benchmarks ready to be phased out, prepare now for future assessment of average interest rates.
- The SEC’s updated auditor independence rules may complexly affect private equity entities.
- The DOL is offering new information on private equity investments in 401(k)s to increase diversification.
Need guidance on your private equity investments?
There have been many recent and upcoming shifts in the private equity industry that are likely to affect your investments and potential future investments. Review four new trends and guidance on what you can do to stay ahead of the curve to make the most of your place in the industry.
SEC modernizes the accredited investor definition
The U.S. Securities and Exchange Commission (SEC) updated the definition of “accredited investor” in the commission’s rules. Under the prior rule, the primary way to qualify as an accredited investor (and be able to invest in private investment companies) was mainly based on annual income or net worth thresholds. The new rule expands the criteria of accredited investor, including new categories in the definition. The amendments recognize the following individuals and entities as accredited investors:
- Individuals with certain professional certifications, designations, or credentials, or other “credentials” issued by an accredited educational institution
- “Knowledgeable employees” of a private fund advisor for the purpose of investing in that fund
- Limited liability companies with $5 million in assets, SEC and state-registered investment advisers, exempt reporting advisers, and Rural Business Investment Companies (RBICs)
- “Family offices” with at least $5 million in assets under management (AUM) and their “family clients”
- Certain other entities that were not formed for the specific purpose of investing in the securities offered
In addition to the amendments above, the term “spousal equivalent” has been added to the accredited investor definition, allowing investors to pool their finances with spousal equivalents to meet the annual income or net worth thresholds. The amendments also expand the definition of qualified institutional buyers and institutional investors.
Stay current with regulatory developments impacting eligibility for participation in private capital markets, including private equity funds. Consider whether you may need to modify your fund’s offering documents.
LIBOR transition set for June 30, 2023
London Interbank Offered Rate (LIBOR) is a key benchmark that facilitates transactions and underpins financial markets around the globe — and it’s set to be phased out on June 30, 2023. It was previously announced that publication would cease at the end of 2021. The structural shift to an alternative rate will affect private equity funds and portfolio companies alike, and both should be prepared to limit downside risk. As a measure of average interest rates at which major global banks could borrow from one another, LIBOR has been used extensively in the U.S. and globally. Banks have used it as a reference to set financial contracts for more than three decades, including debt and financial contracts entered into by private equity funds and portfolio companies.
Due to various concerns from regulators, banks are no longer set to submit rates used to calculate the LIBOR benchmark after June 2023. In the U.S., Secured Overnight Financing Rate is a proposed replacement by the banking community. As contracts continue to reference LIBOR, private equity funds and portfolio companies should prepare for the transition now to limit disruption to operations and performance.
Develop a plan to inventory and review fund and portfolio company contracts for LIBOR language, and be ready to amend or renegotiate existing contracts to include an alternative rate. Service providers can help you understand the accounting and tax implications of switching from current LIBOR-based to alternate rate-based arrangements.
SEC updates auditor independence rules
The SEC updated auditor independence rules, a patchwork designed to help auditors remain objective and impartial in opining on financial statements. Interpreting the rules as they relate to private equity (PE) funds is notoriously complicated, due to the complex nature of the relationships of PE entities (i.e., the relationship of the PE adviser to its portfolio companies and among the portfolio companies themselves) and the adviser’s registration status with regulators (including related or controlled entities to the adviser).
The most relevant changes for PE entities relate to amendments to the definitions of “affiliate,” “investment company complex,” and “audit and professional engagement period,” along with introducing the concept of “beneficial owners with significant influence” in place of “substantial stockholders.” Other changes would impact PE entities tangentially.
Understand updates of independence rules associated with your assurance services provider. Independence is a mutual and shared responsibility of the PE entity and its auditor(s), requiring full disclosure of all relationships inside a PE entity complex and a mutual understanding of independence rules.
Private equity in 401(k) plans
Traditionally, 401(k) (defined contribution) plans include investments in securities in public stocks, bonds, and mutual funds. However, in hopes of increasing diversification in 401(k) accounts, the U.S. Department of Labor (DOL) issued an information letter discussing accessibility to private equity investments through managed asset allocation funds that include a private equity sleeve.
The letter describes a process plan fiduciaries should consider to determine whether a fund’s portfolio that includes private equity investments satisfies Employee Retirement Income Security Act (ERISA) fiduciary standards. The DOL letter includes oversight, liquidity, valuation, alignment with plan characteristics, fees, diversification, and adequacy of information as factors to consider for such investments. The introduction of private equity investments that do not move with the public market adds a new type of diversification, which can complement more traditional equity and fixed-income options.
Stay up to date on regulatory developments. Obtain in-depth knowledge regarding the DOL-issued guidance and review your compliance with ERISA fiduciary standards. Starting the conversation with industry professionals can help you create new opportunities.
How we can help
CLA is here for you every step of the way, whether you’re just getting started in the private equity industry or are fine-tuning your next steps to stay on top of new regulatory changes. We offer a multi-disciplinary team to help you navigate the broad array of audit, tax, and fund administration issues that arise throughout the life cycle of your investments. Connect with our team to see how we can help your specific financial journey.