At its open meeting on February 9, the Securities and Exchange Commission offered up a buffet of proposed regulations of private funds. It’s really an all-you-can eat buffet with six proposed changes across a variety of areas.
The SEC wants private funds to send out quarterly statements to private fund investors. It doesn’t seem that the SEC would require them to be audited. It would have to provide a detailed accounting of all fees and expenses. It sounds like it would some form of standardized reporting. The quarterly reports would have to provide information on fund performance. For “liquid funds, the quarterly statement would provide annual net total returns since inception, average annual net total returns over prescribed time periods, and quarterly net total returns for the current calendar year. For “illiquid funds,” the statement would provide the gross and net internal rate of return and gross and net multiple of invested capital for the illiquid fund to capture performance from the fund’s inception through the end of the current calendar quarter. Not sure what is going to draw lines between “liquid” and “illiquid” funds.
The SEC is proposing that private funds have an annual audit. This seems odd to me. Private funds largely have to do this already under the Custody Rule. Not sure what this regulation would do beyond the Custody Rule, unless it will replace the Custody Rule for private funds.
Adviser-Led Secondaries Rule would require a fairness opinion in connection with an adviser led secondary transaction. This requirement would provide a check against an adviser’s conflicts of interest in structuring and leading a transaction from which it may stand to profit at the expense of private fund investors. Not sure how much this rule would help in already complex transactions
The preferential treatment rule would prohibit private fund advisers from providing preferential terms for redemptions and providing additional information about fund holdings. The proposed rule would go further and prohibit private fund advisers from providing “other preferential treatment” unless disclosed to current and prospective investors. This proposed rule is designed to protect investors by prohibiting specific types of preferential treatment that have a material, negative effect on other investors. Is the SEC trying to kill side letters? This proposal could be a mess.
The prohibited activities rule is side table full of dishes cooked up by the SEC under the umbrella that these practices are contrary to the public interest and the protection of investors
- Charging certain fees and expenses to a private fund or its portfolio investments, such as fees for unperformed services (e.g., accelerated monitoring fees) and fees associated with an examination or investigation of the adviser;
- Seeking reimbursement, indemnification, exculpation, or limitation of its liability for certain activity;
- Reducing the amount of an adviser clawback by the amount of certain taxes;
- Charging fees or expenses related to a portfolio investment on a non-pro rata basis; and
- Borrowing or receiving an extension of credit from a private fund client.
The desert is that all registered investment advisers, not just private funds, have to document their annual review in writing.
Commissioner Peirce, as expected, was against the rule. She sees it as a diversion of resources by the SEC away from retail investor protection. Further she says that maybe the SEC needs to re-think whether there is any reason to keep private placements away from retail investors if the SEC is going to impose retail-like requirements on private investments.
Chair Gensler along with Commissioner Lee and Crenshaw were all in favor of the proposed rule. They all piled on the idea that private funds are a large and growing segment of the investment industry. Of course if investors were unhappy with private funds they would not be investing in private funds and they would not be a large and growing segment of the investment industry.
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