Regulation
New SEC rules for PE managers would alter long-standing industry practices
February 9, 2022 View comments (2)
New rules proposed Wednesday by the Securities and Exchange Commission to tighten reporting and operating requirements for private equity funds would alter practices that the industry has long relied on to reward investors and protect managers from legal liability.
The SEC's proposed rules, which were adopted by a 3-1 vote and will be subject to industry comment for two months, would require private equity funds to make quarterly reports to investors on fees and performance, impose new requirements on general partners carrying out secondary transactions and prohibit certain kinds of preferential treatment of limited partners, among other requirements.
"Private fund advisers, through the funds they manage, touch so much of our economy. Thus, it's worth asking whether we can promote more efficiency, competition, and transparency in this field," SEC Chairman Gary Gensler said in a statement announcing the proposed rules.
The new rules come just days after the SEC proposed to increase the amount of confidential information large funds must share with regulators, increase the speed with which they must share it and boost the number of funds that fall under the reporting requirements. The two sets of proposals are part of Gensler's efforts to increase regulation of private markets.
The new rules would change several aspects of private market regulation that have long been considered fundamental, said Jason Brown, a partner in Ropes & Gray's asset management group and the co-head of its private fund regulatory practice.
"Prior to the new proposals, the Advisors Act was a disclosure-based regime, which means if you disclosed it, and investors still decided to invest in your fund, it was fine," Brown said. "But now, there are five or six activities that even with disclosure, you can't do anymore."
The part of the new SEC proposal likely to catch the most industry attention, Brown said, are the changes to liability and indemnification limits contained in limited partnership agreements, which are negotiated between LPs and GPs. For example, under the proposed rule, a GP cannot be indemnified or have its liability limited for a breach of fiduciary duty or negligence, he said.
"Assuming this rule gets adopted, what is a very standard provision in many, if not most, limited partnership agreements will not be allowed," he said. "Now there is a limit on what you're allowed to seek indemnification for, and what you're allowed to lock your limited liability for. And that's new. I anticipate significant industry push back on that one."
The new rules would also bar preferential treatment, such as granting favorable redemption and liquidity terms to some LPs. Other prohibitions such as banning the accelerated monitoring fees are also expected to attract pushback from the industry, but to a lesser degree, as they are not widely adopted by the industry, Brown said.
The American Investment Council, which represents the private equity industry, said the new rules were unnecessary.
"We are concerned that these new regulations are unnecessary and will not strengthen pension returns or help companies innovate and compete in a global marketplace," Drew Maloney, AIC president and CEO, said in an email.
Under the new rules:
Read the proposed SEC rules on private equity funds in full.
Featured image of SEC Chairman Gary Gensler by Alex Wong/Getty Images
The SEC's proposed rules, which were adopted by a 3-1 vote and will be subject to industry comment for two months, would require private equity funds to make quarterly reports to investors on fees and performance, impose new requirements on general partners carrying out secondary transactions and prohibit certain kinds of preferential treatment of limited partners, among other requirements.
"Private fund advisers, through the funds they manage, touch so much of our economy. Thus, it's worth asking whether we can promote more efficiency, competition, and transparency in this field," SEC Chairman Gary Gensler said in a statement announcing the proposed rules.
The new rules come just days after the SEC proposed to increase the amount of confidential information large funds must share with regulators, increase the speed with which they must share it and boost the number of funds that fall under the reporting requirements. The two sets of proposals are part of Gensler's efforts to increase regulation of private markets.
The new rules would change several aspects of private market regulation that have long been considered fundamental, said Jason Brown, a partner in Ropes & Gray's asset management group and the co-head of its private fund regulatory practice.
"Prior to the new proposals, the Advisors Act was a disclosure-based regime, which means if you disclosed it, and investors still decided to invest in your fund, it was fine," Brown said. "But now, there are five or six activities that even with disclosure, you can't do anymore."
The part of the new SEC proposal likely to catch the most industry attention, Brown said, are the changes to liability and indemnification limits contained in limited partnership agreements, which are negotiated between LPs and GPs. For example, under the proposed rule, a GP cannot be indemnified or have its liability limited for a breach of fiduciary duty or negligence, he said.
"Assuming this rule gets adopted, what is a very standard provision in many, if not most, limited partnership agreements will not be allowed," he said. "Now there is a limit on what you're allowed to seek indemnification for, and what you're allowed to lock your limited liability for. And that's new. I anticipate significant industry push back on that one."
The new rules would also bar preferential treatment, such as granting favorable redemption and liquidity terms to some LPs. Other prohibitions such as banning the accelerated monitoring fees are also expected to attract pushback from the industry, but to a lesser degree, as they are not widely adopted by the industry, Brown said.
The American Investment Council, which represents the private equity industry, said the new rules were unnecessary.
"We are concerned that these new regulations are unnecessary and will not strengthen pension returns or help companies innovate and compete in a global marketplace," Drew Maloney, AIC president and CEO, said in an email.
Under the new rules:
- Registered private fund advisers would be required to file financial statements quarterly, detailing fees and expenses, manager compensation, and fund performance.
- Qualifying private funds would be required to undergo annual audits and notify the SEC of certain events.
- Private fund managers would be required to provide limited partners with a fairness opinion produced by an independent third-party when conducting GP-led secondary transactions.
- Private fund advisers, including those not registered, would be prohibited from engaging in practices that are "contrary to the public interest and the protection of investors."
- Private fund advisers would be prohibited from providing preferential treatment to investors that has a material negative effect on other investors, and would be required to disclose all other forms of preferential treatment.
- All registered advisers, including those that do not advise private funds, would have to document the annual review of their compliance policies and procedures in writing.
Read the proposed SEC rules on private equity funds in full.
Featured image of SEC Chairman Gary Gensler by Alex Wong/Getty Images
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