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SEC proposes sweeping changes that affect secondaries industry

The proposals include the requirement to obtain a fairness opinion on the prices of secondaries transactions.

Private fund advisers will have to brief their investors on fees and expenses every quarter, and audit their funds yearly, under rules the US Securities and Exchange Commission voted on Wednesday to put out for public comment.

The sweeping rules, which won the Commission’s approval, 3-1, at the SEC’s open meeting Wednesday would also:

  • Require advisers to “obtain a fairness opinion” on the pricing of GP-led secondaries transactions;
  • Ban a raft of fees, expenses and business practices in all private funds, registered or not;
  • Prohibit “preferential terms” to select investors in all private funds, registered or not;
  • Expand the scope of books and records rules: and would
  • Require all registered advisers – private or not – to document their annual audits.

SEC chairman Gary Gensler promised to bring “enhanced disclosures” to an industry that his staff estimates handles some $18 trillion in gross assets. Its backers and its opponent – Republican commissioner Hester Peirce – agree that the proposed rules go much further than that.

“After a decade of oversight of private fund advisers and multiple risk alerts,” Democratic commissioner Caroline Crenshaw said in supporting the proposal, “it seems requiring disclosures alone is likely not enough to adequately protect investors.”

‘Large and growing larger’

Gensler and his allies say the rules are designed to help regulators to get a closer look at a secretive industry that’s has become essential to the world economy. They’ll also help protect an increasingly growing body of ordinary investors – or the ordinary people behind huge pension funds – from shady practices that have grown in the industry’s darkness, Gensler and his allies claim.

“If adopted, it would help investors in these funds on the one hand, but also the funds themselves on the other hand,” Gensler said. “It matters because these funds are large and growing larger. Thus, it’s worth asking whether we can increase efficiency, transparency and competition in this field.”

Peirce condemned the proposal. She said it was a “sea change” in how the Commission regulates private funds. It’s also a standing insult to the “well-heeled, well-represented investors who can fend for themselves,” Peirce said, using the language from a seminal Supreme Court decision that gave private funds their cover against disclosure rules.

Closer look

Here’s a closer look at what the proposed rules would do:

Quarterly Statements. Applies to registered private fund advisers. They’d have to send quarterly statements to their investors that include:

  • “A detailed accounting of all fees and expenses”;
  • “Compensation or other amounts paid by the private fund’s portfolio investments to the adviser or any of its related persons”; and
  • Fund performance. “For liquid funds, the quarterly statement would provide annual net total returns since inception, average annual net total returns over prescribed time periods, and quarterly net total returns for the current calendar year,” the Commission says. “For illiquid funds, the statement would provide the gross and net internal rate of return and gross and net multiple of invested capital for the illiquid fund to capture performance from the fund’s inception through the end of the current calendar quarter.”

Audit rule. Applies to registered private fund advisers. It would require at least yearly audits and at a fund’s liquidation. Investors would have to get copies of the audit “promptly.”

Secondaries rule. Applies to registered private fund advisers. They’d have to obtain “a fairness opinion” from a certified evaluator before carrying out a GP-led secondaries process. The auditor will weigh in on whether the offered price is fair. Advisers would also have to share a summary “of any material business relationships the independent opinion provider has or has had within the past two years with the adviser or any of its related persons.”

Prohibited activities rule. Applies to all private fund advisers, registered or unregistered. Would ban fees or expenses, including:

  • So-called “accelerated monitoring fees,” and fees “associated with an exam or investigation of the adviser”;
  • Reimbursement, “indemnification, exculpation or limitation of its liability” related to exams, enforcement or litigation;
  • Offsetting taxes by reducing the amount of an adviser clawback;
  • Charging portfolio investment fees or expenses “on a non pro-rata basis”; and
  • Borrowing or receiving a credit line from a private fund client.

Preferential treatment rule. Applies to all private fund advisers, registered or not. These would prevent advisers from picking favourites for redemptions “or information about portfolio holdings.” It would also ban advisers from offering “other preferential treatment unless disclosed to current and prospective investors” unless they properly disclosed it. Secondary preferences, for instance, will be exempt from preferential treatment rules so long as they disclose the preferential treatment to their investors, Gensler said.

Compliance risk rule. Applies to all registered funds, private or not. Would require advisers to document their annual audits in writing.

Comments are due within 60 days of the notice posting in the Federal Register, Gensler said.

– This article first appeared in affiliate publication Regulatory Compliance Watch.