If the proposed SEC rule changes go into effect, Private Equity firms will need a plan for how to deliver the required performance data to their limited partners.

The U.S. Securities and Exchange Commission, or SEC, has proposed a number of significant rule changes that will affect how Private Equity firms do business. These rules, which are outlined in a lengthy proposal, would be added to the existing Investment Advisers Act of 1940, and run the gamut from increased transparency requirements regarding fund performance and fees to outlawing certain practices altogether.

SEC calls for greater transparency in Private Equity

The provisions regarding disclosures to investors are summed up thusly by the SEC: “We propose to require registered investment advisers to private funds to provide transparency to their investors regarding the full cost of investing in private funds and the performance of such private funds. We also are proposing rules that would require a registered private fund adviser to obtain an annual financial statement audit of each private fund it advises and, in connection with an adviser-led secondary transaction, a fairness opinion from an independent opinion provider.”

Some of the most significant new rules deal with quarterly disclosures, including:

  • A rule that “would require an investment adviser that is registered or required to be registered with the Commission to prepare a quarterly statement that includes certain information regarding fees, expenses, and performance for any private fund that it advises and distribute the quarterly statement to the private fund’s investors within 45 days after each calendar quarter end.” Many fund managers already do this, but until now, there was no requirement.
  • A rule requiring quarterly statements regarding fees and expenses, “including fees and expenses paid by underlying portfolio investments to the adviser or its related persons.” This would include a detailed table accounting for all compensation, fees, and other amounts paid.
  • A rule that would require advisers “to include standardized fund performance information in each quarterly statement provided to fund investors.” This would include performance information calculated on a quarterly basis and on an annual basis since the fund’s inception.
  • The proposal also includes specific instructions regarding the preparation and distribution of quarterly statements, reporting requirements for specific fund structures, format and content requirements, and recordkeeping rules regarding these quarterly statements.

Another big change would be a rule that requires private fund advisers “to obtain an annual audit of the financial statements of the private funds they manage.” The full SEC proposal goes into great detail on the standards for these audits and how the results should be distributed.

Prohibited activities and what is likely to happen next

While many in the industry agree that greater transparency is a good thing for investors, there is disagreement as to whether all of these proposed rules are necessary. There are several other changes that have drawn even more scrutiny, specifically those that will “prohibit a private fund adviser from engaging in certain sales practices, conflicts of interest, and compensation schemes that are contrary to the public interest and the protection of investors.”

Prohibited activities would include:

  • Charging certain fees, including accelerated monitoring fees or fees associated with an investigation of the adviser by government or regulatory authorities.
  • Reducing the amount of any adviser clawback “by actual, potential, or hypothetical taxes applicable to the adviser.”
  • Directly or indirectly “borrowing money, securities, or other fund assets, or receiving a loan or an extension of credit, from a private fund client.”
  • “Seeking reimbursement, indemnification, exculpation, or limitation” of the adviser’s liability “by the private fund or its investors for a breach of fiduciary duty, willful malfeasance, bad faith, negligence, or recklessness in providing services to the private fund.”

This last change, which would outlaw hedge clause provisions, is likely to draw a great deal of pushback, as it could potentially open up PE firms to greater risk. While the overall proposal passed by a 3-1 vote, it is still possible for changes to be made before it is adopted.

The proposal is currently in its 60-day comment period where interested parties can have their voices heard by making a public comment. We will continue to update our readers as the rules become finalized, but it’s safe to assume that in some capacity, there will be greater transparency requirements for PE managers. When the time comes, will your firm be ready?

How JTC Americas can help

While we don’t know the final form these rule changes will take, it’s all but certain we’ll see greater reporting requirements, likely involving fund performance and fee data on a quarterly basis. Managers need to think about how they’ll be able to provide this data to limited partners in an efficient and cost-effective manner, and the right third-party fund administrator can make the transition easier.

JTC Americas’ Private Equity fund administration solution is built around our award-winning eSTAC technology platform. Our investor portal provides 24/7 visibility into fund status, capital account financial data, and document sharing, making it easier for you to provide investors with the information they want when they want it. With JTC, you can deliver better information faster, with industry-leading security, transparency, and compliance tools, so as industry regulations evolve, you can adapt quickly.

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Learn more about JTC Americas’ technology-based solution by downloading our Private Equity fund administration collateral!