August 24 (Preqin News) – In announcing its final decision on new rules and amendments to existing legislation on private funds advisors, the SEC on Wednesday stepped back from some of the more contentious proposals it first put forward in February 2022.

Despite the dilutions, the new framework illustrates that the regulator is determined to shine a light on the private funds industry, particularly as more state pensions increase their allocations to private equity, venture capital, and real estate funds. With the latest round of regulatory interventions, the SEC steps closer to that objective.

‘Private funds and their advisers play an important role in nearly every sector of the capital markets,’ SEC Chair Gary Gensler said in a statement following Wednesday’s meeting. ‘By enhancing advisers’ transparency and integrity, we will help promote greater competition and thereby efficiency. Consistent with our mission and Congressional mandate, we advance today’s rules on behalf of all investors — big or small, institutional or retail, sophisticated or not.’

Rapid growth in private markets has drawn greater scrutiny from regulators, who say that more transparency around private funds’ activities is required to protect investors. This is in part because more individuals are exposed to the sector as public pension funds increase their exposure to asset classes such as private equity. 

SEC efforts to improve transparency include requiring registered funds to provide quarterly statements containing information on fees, performance, and expenses, as well as annual audits for every fund.

Some of the adopted proposals were amended from their initial versions, with some proposed ‘prohibited’ activities being downgraded to ‘restricted’. Some of the more contentious proposals were dropped altogether, including one relating to liability that would have exposed fund managers to legal action in cases of negligence, rather than gross negligence. 

Specific changes following yesterday’s meeting include

  • The final rule downgraded the charging of certain fees and expenses (such as those related to regulatory, examination, or compliance matters) from a ‘prohibited activity’ in the proposals, to a ‘restricted activity’ in the final version. All private funds will be able to continue charging for those items as long as the activity is disclosed and, if necessary, also receives consent from investors.
  • The SEC also initially proposed to bar all private funds from offering preferential terms on redemption rights and providing information about fund holdings and exposures to some investors. In the final version, private funds will continue to be allowed to offer preferential treatment, as long as the same rights and information are offered to all other investors.
  • Meanwhile, an initial proposal that, for certain secondary-led transactions, a ‘fairness opinion’ would be required from all SEC-registered private funds, was broadened to include a ‘valuation opinion’ as an alternative. 

Nonetheless, some industry groups remain critical of the new rules and amendments. The Alternative Investment Management Association (AIMA) said that it welcomed the revised proposals, on the basis that the originals, ‘…contained a number of terms that would have stifled innovation, imposed disproportionate burdens on private fund market participants…’ as well as hindering the ability to deliver value to investors in a manner that it said balanced risks and rewards.

‘We note that the final version of the rules reflects many of the concerns raised by AIMA and other industry stakeholders. However, the rules adopted today still contain several areas of concern for AIMA and our global membership, which includes fund managers and investors of all sizes, and the final text will need to be examined in detail to identify where these remain,’ it said in a statement following the SEC’s announcement.

During the comment-gathering process following the initial proposals, several respondents had requested clarification on the proposed one-year compliance period following the adoption of the rules. In Wednesday’s announcement, the SEC revealed that registered private funds would now be given 18 months to comply with the rules on statements and audits. For secondary transactions, preferential treatment and all restricted activities rules, all private fund advisors will be given 12 months to comply if they have total assets under management (AUM) of $1.5bn or more, or 18 months if less than $1.5bn AUM.

The Commission also addressed so-called grandfathering concerns, after stakeholders questioned whether the new rules and amendments to earlier legislation would apply to existing contractual agreements. If they did, it could mean revising previously agreed terms. Announcing a ‘legacy status’ ruling, some of the prohibitions and restrictions outlined in the rules will not apply to agreements activated prior to the new compliance date, where that applies. 

‘The final rule proposal from the Commission addresses some of the market's largest concerns about the initial proposal, namely dropping a change in negligence standards and adding in a provision to handle legacy agreements with investors,’ says Nicholas Mairone, AVP, Research Insights, at Preqin. ‘However, the SEC preserved requirements for quarterly disclosures and annual audits that attempt to standardize reporting from private funds regarding both fees and performance. I’d expect court challenges to these rules, and also, going forward, I'd expect the SEC and other regulators to continue to focus on the private funds regulatory framework.’

 

Preqin will be covering this story as it develops and as the industry responds to the SEC’s next move. Look out for updates from Preqin News, and further discussion in our daily newsletter, Preqin First Close

 

The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin providing the information in this content accepts no liability for any decisions taken in relation to the above.