An Update on the SEC’s Private Fund Rule

While the proposed private fund transparency rules don’t address the work of financial advisers as directly as some other outstanding proposals, they have the potential to shake up a growing sector of the financial markets.

With so much adviser-focused regulatory activity happening in 2022—from the final implementation of the Department of Labor’s new prohibited transaction exemption to the Securities and Exchange Commission’s proposal to require advisers to disclose ESG-related information—it is easy to forget the fact that, back in January, the SEC also proposed an ambitious regulation addressing the growing private funds industry.

According to Ethan Corey, an attorney with Eversheds Sutherland, the proposal regarding private funds is sufficiently meaningful as to demand the attention of financial advisers and institutional investors. At the very least, these parties may find that their investment provider partners or clients have strong viewpoints about the SEC’s rulemaking, and an adviser’s investment process may need to be updated if/when a final rule takes effect.  

What the SEC Proposed

Specifically, the SEC has proposed substantial amendments to Form PF, the confidential reporting form for certain SEC-registered investment advisers to private funds, which are funds that are excepted from the definition of “investment company” by virtue of the exceptions set forth in Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940. The SEC’s leadership says the proposed amendments are designed to enhance the Financial Stability Oversight Council’s ability to assess systemic risk, as well as to bolster the SEC’s overall regulatory oversight of private fund advisers and its investor protection efforts, in light of the growth of the private fund industry.

Corey says the private fund rulemaking proposal is among the most significant expansions of the regulation of private fund advisers since they were first required to register with the SEC as a result of Dodd-Frank Act. For example, the proposed rules include a new requirement that private funds give their investors a quarterly statement with all of the expenses and fees associated with the fund. Another part of the proposal would require that advisers file reports—within one business day—of events that indicate significant stress at a fund that could harm investors or signal risk in the broader financial system.

The proposed amendments would provide the SEC and FSOC with more timely information to analyze and assess risks to investors and the markets more broadly. The proposal would also decrease the reporting threshold for large private equity advisers from $2 billion to $1.5 billion in private equity fund assets under management. The SEC’s leadership has argued that lowering the threshold would result in reporting on Form PF that continues to provide robust data on a sizable portion of the private equity industry.

Finally, the proposal would require more information regarding large private equity funds and large liquidity funds to enhance the information used for risk assessment and the SEC’s regulatory programs.

Attorneys say the SEC’s messaging shows the regulator feels it cannot rely on the private fund industry itself to make adequate disclosures under the current framework. Parts of the proposal seem to require that certain private fund advisers engage a third party to provide fairness assessments regarding how the fund is constructed and distributed, while other parts would require that new disclosures are made to all investors in a fund about any side letters or communications certain other investors are receiving.

What the Industry Is Saying 

Corey says the many comments that have been submitted to the SEC regarding the proposal are quite varied in terms of their style, point of view and recommendations. The private fund industry itself, he says, is generally “highly skeptical” of what the SEC says it is trying to accomplish.

“The letters that have been sent have been interesting,” he says. “When the proposal was first published, I thought the industry’s point of view would be pretty uniformly negative, but that actually isn’t the case. Not surprisingly, a lot of people within the private fund industry itself are pretty negative on the rule proposal, but that view is not universal, and there has been a lot of supportive commentary from various stakeholders.”

Those who criticize the SEC’s proposal say the regulator is, in effect, sticking its nose into private business relationships that are undertaken among sophisticated, informed parties, and that fund advisers will unfairly have to begin sharing information in their disclosures that, currently, clients or other parties have to bargain for or simply cannot access on demand. That private fund investors must first be accredited by the government to trade securities that may not be registered with financial authorities before they can participate in this marketplace gives that point of view some credibility, Corey says. On the other hand, the SEC has been signaling for several years that it wants to see private fund advisers improve their disclosure methodologies and conflict-of-interest mitigation practices.

“There is a sizable group of commenters who say the SEC is right on here—who believe there are ongoing abuses in the private fund industry and that the SEC is right to have stepped in and made these proposals to try and tamp down on that,” Corey says. “This viewpoint is probably in the minority in terms of the financial services industry. But the people who are the investors in the private fund industry appear to be more in favor of the SEC’s proposal, if only because it would give them added negotiating leverage.”

What Comes Next

While the original comment period for the private fund proposal technically ended in mid-June, the SEC’s website is still accepting public comments, meaning it is apparently not too late for stakeholders to make their voice heard. Should the proposal follow the typical course for such regulations, a final version of the regulation will likely emerge at some point this year, likely with a multi-year implementation process.

For his part, Corey anticipates significant legal wrangling to unfold around the final proposal. He also says some parts of the adviser industry may find they are more directly impacted by the rulemaking than expected. Specifically, much of the rulemaking package would affect only registered investment advisers serving private funds, but some elements would affect exempt reporting advisers, state-registered investment advisers and unregistered foreign investment advisers.

Furthermore, while most of the proposal would affect only advisers that advise private funds, SEC’s proposal to require SEC-registered advisers to document the annual review of their compliance policies and procedures in writing would apply to any registered investment adviser, regardless of whether it advises a private fund.