The U.S. Securities and Exchange Commission has tightened its focus on private capital and private equity funds in recent years. The Marketing Rule went into effect November 4, 2022, and advisers are waiting to see if the numerous proposed amendments to the Investment Advisers Act and Form PF go through. These new rules could drastically alter advisers’ internal compliance procedures.
Given the SEC’s intense scrutiny of the private markets, Ontra COO Ben Levi sat down with Norm Champ, P.C., the former deputy director of the SEC’s Office of Compliance. They discussed these recent developments and how advisers can prepare for the evolving regulatory landscape.
Below are select highlights of their discussion, which you can watch on demand: Former SEC director shares his thoughts on evolving private market regulations.
Proposed SEC outsourcing rule
Levi and Champ first discussed the most recent proposal, which would require registered investment advisers to perform due diligence before retaining outsourcing providers for certain advisory functions and monitor and report on those outsourcers.
“The rule is focused on outsourcers that have some role in the investment decision process,” said Champ. “I take it as somewhat of a victory that it’s relatively narrow.”
Champ noted that these proposed rules come without guidance. He said he expects the public comments will focus on how advisers should determine which service providers the rule covers.
SEC Marketing Rule
The new SEC Marketing Rule went into effect recently, yet many industry professionals suspect that some advisers aren’t in full compliance yet. Champ recommended firms steadily work toward reaching full compliance as soon as possible.
“There has never been a rule of this magnitude and impact that has gone into force without a significant amount of guidance from the SEC,” said Champ. “There has been none except a couple of early FAQs, and that’s extremely unusual. We don’t have the type of staff guidance we typically have.”
Firms are concerned with how to calculate the net performance if necessary. Champ said he’s been working with clients on determining whether rules require the net calculation and, if so, how to proceed.
Firms also must prepare for upcoming SEC exams focused on the Marketing Rule. In areas where firms are unsure of what to do, Champ said, “Pick a reasonable path and explain very carefully what you chose to do.”
Midterm elections and the economy
Levi and Champ also discussed the potential impact of the midterm elections and the economy on SEC initiatives and enforcement. Champ suspected that if one or both of the houses of Congress changed control, there would be a different attitude from the hill. However, he also believes Chair Gary Gensler will continue to try and adopt the rules the SEC has proposed no matter the outcome of the midterms.
As for whether the economy will impact how the SEC moves forward, Champ said many of his clients are asking the same thing. “You do have to wonder,” said Champ. “We’ve had terrible inflation, and we had a positive growth quarter but two negative growth quarters. Will there be any thought to easing up?”
The motivation behind the SEC’s push
Champ spoke about the lack of a clear explanation for the SEC’s focus on private capital. He felt the approach was somewhat logical compared to the increased regulation of public companies. However, the risks the SEC is attempting to mitigate aren’t clear. Unlike Dodd-Frank, the current proposals aren’t driven by a federal statute or a financial crisis.
“It seems like the SEC believes investors in private funds are not capable of evaluating the risks in their funds and negotiating for their interests in those funds on terms that are advantageous to them,” said Champ. “I would argue the investors are very well equipped to negotiate.”
Champ acknowledged the increase in SEC exams of private funds as well as a lower bar between exams and enforcement investigations. “One of the side effects of that is that cases are being opened on facts that are much thinner and less compelling,” said Champ. “We’re seeing cases opened and then dropped.”
It’s also clear the new Marketing Rule will be an exam focus. Champ noted that in recent years, SEC staff had been less focused on marketing materials, and were providing fewer comments on those materials. One theory is that the SEC was waiting for the Marketing Rule compliance date. “Now that we are into this period, I do think the focus is going to be on November 4 and after and what firms did to comply.”