In February, the SEC announced a number of proposed regulatory reforms that would fundamentally impact private fund managers in the US. The proposals represent the most extensive reforms since the passage of the Dodd-Frank Act of 2010 and target a sector that holds more than $18 trillion in gross assets. The proposals in many cases apply not only to SEC-registered advisers but also to U.S. and non-U.S. private fund advisers that rely on the SEC's 'exempt reporting adviser' exemptions.
While managers in the UK may not be entirely familiar with the implications of the proposed regulatory reforms, close attention should be paid to the latest developments, which are designed to capture all fund fees and expenses. If implemented, how will this influence the industry? KPMG in the Crown Dependencies has outlined the proposals' notable key takeaways and how this would ultimately impact managers and investors.
- Require private fund advisers registered with the SEC to provide investors with quarterly statements detailing information about private fund performance, fees, and expenses.
- Require registered private fund advisers to obtain an annual audit for each private fund and cause the private fund's auditor to notify the SEC upon certain events.
- Require registered private fund advisers, in connection with an adviser-led secondary transaction, to distribute to investors a fairness opinion and a written summary of certain material business relationships between the adviser and the opinion provider.
- Prohibit all private fund advisers, including those that are not registered, from engaging in certain activities and practices that are contrary to the public interest and the protection of investors.
- Prohibit all private fund advisers from providing certain types of preferential treatment that negatively affect other investors while also prohibiting all other types of preferential treatment unless disclosed to current and prospective investors.
The extent to which the proposals would prohibit all private fund advisers is all-encompassing, from engaging in several activities, including seeking reimbursement, indemnification, exculpation, or limitation of liability for certain activity, charging certain fees and expenses to a private fund or its portfolio investments. They would also extend to fee charges or expenses related to a portfolio investment on a non-pro rata basis and borrowing or receiving an extension of credit from a private fund client.
The SEC has positioned these reforms as protecting private fund investors; however, the content has raised eyebrows within the industry. If enacted, additional costs will be incurred by private fund advisers and their funds with the requirements for annual audits, quarterly statements, and fairness opinions necessitating the engagement of external providers, the costs of which will ultimately be borne by investors. There are also likely to be shortfalls in many (notably smaller) private fund advisers internal reporting systems and processes that will require investment to remediate.
Furthermore, it is possible that the proposed reforms are misguided in seeking to protect private investors, as investors in private funds are typically sophisticated enough and sufficiently resourced to protect their own commercial interests. Traditional sources of capital in private funds have the means and capability to perform extensive due diligence and negotiate terms with private fund advisers. Additionally, these proposed rules may also have an unintended adverse consequence of discouraging new private advisers, given the additional costs involved and limitations on offering preferential treatment to certain investors via confidential side letters.
From the vantage point of the SEC, there are compelling reasons for reforms to be proposed to protect investors. They will provide greater transparency and compel practices that do not incentivise advisers to place their interests ahead of their private funds. In particular, the requirement for SEC-registered advisers to provide standardised reporting to investors detailing compensation, fees, and expenses, etc. and mandating uniform definitions of performance metrics such as IRR and MOIC will likely be welcomed by existing and prospective investors. In addition, annual audits will provide an important check on advisers' valuations of private fund assets, which often serve as the basis for the calculation of adviser fees and can be highly subjective and prone to bias. Interestingly at the time of publication, the SEC has reopened the comment period for a further 30 days. Only time will tell whether these are the right proposals for the industry and if they will prove successful in striking a balance between protecting investors and imposing a regulatory burden on private advisers.
While the reforms are left hanging in the balance, KPMG in the Crown Dependencies is weighing up the proposals' pros and cons, actively providing advice for clients, in order to get a transparent understanding of the proposed rules and the overall impact the changes will have on the industry. KPMG wishes to provide investors comfort in giving a concise step forward for when the comment period ends, and the rules are finalised.
If you wish to seek more advice, please contact Simon Guilbert: sguilbert@kpmg.com
