In what many are calling the most sweeping securities reform since the Dodd-Frank Act, the Securities and Exchange Commission will consider tomorrow whether or not to adopt proposed rules and amendments that will impact the way that private equity, hedge, real estate funds and their advisors do business.
The 236-page package of changes encompasses an overhaul of regulation of the $45 trillion private fund industry that includes changes to regulatory monitoring, compliance, reporting and compensation. The package pits the SEC and consumer groups against almost all of Wall Street.
The proposed rules would require registered investment advisors to provide quarterly statements to investors detailing performance and expenses and fees, including compensation, carried interest, performance compensation, portfolio company remuneration and any related management fee offsets.
Gail Bernstein, general counsel, Investment Adviser Assocation, said "if the rule comes out even close to what is proposed, it would make private funds much more expensive and inefficient. It would also lead to far less investor access and a less competitive industry. And, because the proposal is so overbroad and prescriptive, we are unlikely to see a commensurate investor benefit."
Private funds offer "significant benefits to investors and the capital markets, including, for example, portfolio diversification and risk management for investors and vital investment capital for companies," she added. Advisors that manage private funds, like all investment advisors, are already subject "to a robust regulatory framework that includes an overarching fiduciary duty to clients," Bernstein said.
The Securities Industry and Financial Markets Association (SIFMA) is also opposed.
The SEC said the proposal is intended to enhance its ability to monitor systemic risk and bolster oversight, but “the agency never identified a lack of current reporting with respect to private funds as a data gap or systemic vulnerability in its 2021 Annual Report,” attorney Lindsey Weber Keljo, head of SIFMA's asset management group, said in a comment letter.
The SEC’s 2021 report included discussion specifically relating to “major gaps and deficiencies in the range and quality of data available to financial regulators, but it did not cite the need for current reporting from private funds,” Keljo said.
The second “overarching goal” in the proposal, she said, is investor protection. While the proposal does outline in its conclusion potential conflicts of interest associated with market failures and other triggering events, “the SEC does not explain why these conflicts are so critical as to require current reporting and near real time SEC attention,” Keljo said.
“We are concerned that the Commission may be reinterpreting its investor protection mission as a mission to mitigate market or investment risk, which we believe would be misguided,” she added, noting that private equity funds already are required to market and sell only to sophisticated investors who meet wealth thresholds. As a result, the SEC proposal would “expend regulatory resources to protect the most sophisticated investors—those who have already been determined to need less protection than retail investors,” she concluded.
In contrast, Better Markets, an investor protection association formed in the wake of the 2010 market meltdown, said in a statement today that the SEC should adopt the proposed private fund advisor rules to protect investors from conflicts of interest and shady side agreements.
The reforms in the proposed rules are needed to protect everyday Americans, who participate in the private funds market through pension plans or mutual funds, from conflicts and costly side agreements, Better Markets Legal Director Stephen Hall said.
In the fourth quarter of 2020, public pension plans had $1.5 trillion invested in private funds, while private pension plans had $1.248 trillion invested in private funds, according to Better Markets.
The SEC should adopt the rules to protect investors from “the appalling array of unfair, predatory, and opaque practices that have become all too common in the world of private fund advisers. These rules include important and overdue reforms for an industry that has escaped meaningful transparency and oversight for far too long even though it affects tens of millions of hardworking Main Street Americans,” Hall said.
Currently, fund disclosures do not offer sufficient detail or clarity to enable investors—even sophisticated investors—to develop a clear understanding of the fees and expenses the fund must bear or how well the fund is actually performing, the group says, adding that the proposed required quarterly statements will better inform investors about the fees and expenses charged to the fund and the performance of the fund since inception.
Hall also gave high marks to the proposed requirement that private funds obtain a financial audit annually and that advisors obtain a fairness opinion when they suggest secondary transactions to investors such as selling their interests in a fund or exchanging interest in one private fund for another.
The proposed rules would also prohibit private fund advisors from limiting or eliminating their liability for advisor misconduct, including by limiting liability for a breach of fiduciary duty—something that 71% of investors report having been done on half of their funds, according to Better Markets.
The SEC’s package would also limit preferential treatment of certain investors regarding redemptions or information about fund holdings or investment exposures unless the advisor provides written disclosures to prospective and current investors.