Changes to Side Letters, Audits, and More: Unpacking the SEC’s New Rules for Private Funds

Regulators voted Wednesday to approve new rules for asset managers, including private equity firms and hedge funds.


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The Securities and Exchange Commission adopted new rules on Wednesday governing private equity, hedge funds, and other asset managers that offer unregistered investment funds — the biggest changes to such rules since the Dodd-Frank Act in 2010.

Under the new rules, private fund advisors registered with the SEC must provide their investors quarterly statements that include fund-level fees, expenses paid by the fund, certain compensation and other money paid to the fund company, and performance. Investment advisors offering private funds must also get an annual audit for each private fund it advises and distribute it to its investors. Asset managers will also be required to provide a fairness opinion, or valuation opinion, for adviser-led secondary transactions.

The rules forbid private fund advisors from giving “preferential treatment” to certain investors — a common practice through so-called side letters between managers and institutional investors — unless they offer the same terms to other current and prospective investors in a fund. The rules also barred “preferential treatment” for some investors that might have a material negative effect on others. For example, giving some investors a heads up on information so they could seek redemptions before other shareholders.

The commissioners voted 3-2 to approve the rules, which will be sent to the federal register and go into effect within 60 days. Funds will have 18 months from the effective date to comply with the quarterly statement and audit rules. Advisors will have at least 12 months to comply with the secondaries, preferential treatment, and other rules.

The rules mean major changes are coming to a growing industry with $25 trillion in assets and stakeholders that include the biggest asset managers, pension plans, university endowments, and wealthy individuals.

Proponents and opponents both got things that they wanted in the final rule.

“Everyone on both sides is used to the disclosure-based regime that we have lived under since 1940; most of the ways we address conflicts of interest and transparency is by shining sunlight on them and providing more information. I think a lot of the industry was wringing their hands at the proposal because it was not disclosure-based, it was kind of prescriptive in its approach. And I think the final rule is much more disclosure-driven and that’s going to be viewed as welcome by the industry,” said Adam Kanter, a partner at law firm Mayer Brown.

Gail Bernstein, general counsel for the Investment Advisor Association, an industry group that represents asset managers, said the organization still has concerns about the rule. “The devil will be in the details,” she wrote in an email shortly after the commissioners voted on the final rule that is 660 pages long. But the new rules adopted are generally more reasonable than the ones that were proposed and better tailored to the objectives of the SEC, she said.

The Institutional Limited Partners Association (ILPA) considered the final rules a win for its members, who are some of the largest investors in private funds.

“We appreciate the intention of the SEC’s Private Fund Advisers final rule to promote greater governance, alignment, and transparency across private funds. Based on today’s meeting of the commissioners and our early understanding of what the rule encompasses, we’re heartened to see the rule take steps forward on fee and expense reporting and begin to address persistent conflicts of interest we’ve observed for some time, such as with GP-led secondaries transactions,” said Jennifer Choi, ILPA chief executive.

Although, like everyone, ILPA is now doing a more thorough analysis of the rule this week and said it will continue to fight for the limited partners it represents.

Overall, the new requirements of private fund managers will increase their cost of doing business, according to Rory Callagy, associate managing director at Moody’s Investors Service. That will have an outsize impact on small and medium-size asset managers and potentially lead to more consolidation in the industry, he said.

The same concerns, as well as others, were raised during the comment period for the proposed rule. At least one group, the Managed Funds Association (MFA), has already aired the possibility of challenging it in court.

“MFA continues to have concerns that the final rule will increase costs, undermine competition, and reduce investment opportunities for pensions, foundations, and endowments. MFA will assess the final rule and work with our members to determine the appropriate next steps to protect the interests of alternative asset managers and their investors, including potential litigation,” said Bryan Corbett, president and CEO of MFA.

During the meeting Wednesday, commissioners discussed the regulator’s authority to enact such rules for private funds, something Gary Gensler, chairperson of the SEC, addressed just before the vote.

“Before I call the vote, I just want to say I think that we’re doing this grounded in clear authorities from Congress, clear authorities that were augmented and added to in the Dodd-Frank reform act,” Gensler said. “I’m quite confident and comfortable with that analysis.”