Michael Nadeau General Partners have every reason to believe the U.S. Securities and Exchange Commission will continue to closely scrutinize their fees and expenses, conflicts of interest, preferential treatment of limited partners, and more. Firms must be prepared to meet new compliance requirements if proposed amendments move forward.
How well does your asset management firm track its obligations? In the Stricter SEC Regulation on the Horizon: Are You Prepared? webinar, Ontra’s VP/GM of Insight Miles Chan tackled that question and much more.
Here are five key takeaways from the webinar:
Massive asset growth in the private markets is one of the reasons for SEC interest
The amount of assets under management fund managers oversee has grown tremendously over the past five to seven years. According to the SEC’s Division of Investment Management, there was about $9 trillion of gross AUM in the private markets in 2014; Seven years later, that amount has doubled, with around $18 trillion in AUM for 2021.
“Traditionally, the players in private markets — both managers and investors — have been extremely sophisticated,” Chan said. “The SEC and regulators have largely left those parties to contract for themselves and set terms directly.”
One example is the world of side letters, the bespoke set of agreements between fund managers and investors. The traditional approach from regulators was hands-off. However, with the enormous growth in the markets comes more scrutiny from officials.
“The SEC is starting to pay real attention to what’s actually in these contracts,” Chan said. “They’re making sure the GPs or the fund managers follow up on the promises they’ve made to their investors and LPs.”
The new demographics of the private markets are another reason for increased interest
As private market activity has expanded, the investor pool has also broadened. It’s shifted from traditional endowments, hedge funds, and sovereign wealth funds to more individual, high-net-worth participants.
“While these folks are, of course, sophisticated investors, they generally don’t have as much infrastructure around them as the larger, institutional investors to protect them from some of the nuances in the markets,” Chan said.
The SEC also pays attention to where investor money leads back to individuals. Pension funds, endowments, and union funds lead back to people like retirees, union workers, and educators.
“They’re trying to make sure that these people’s money is being protected and treated fairly across a broad set of investors with different priorities and bargaining power in a given fund,” Chan said.
The first bucket of proposed amendments relates to Form PF
Form PF is a regulatory filing that requires private fund advisers over $150 million AUM to report regulatory assets under management to the Financial Stability Oversight Council. Adopted in 2011 after the financial crisis, Form PF allows the Council to monitor systemic risk in the American financial system.
Proposed amendments to Form PF include new reporting requirements for large hedge funds and private equity advisers, a lower reporting threshold for private equity advisers, and further questions for advisers on portfolio company financing, investment strategy, and more.
“Here, the SEC is digging deeper with Form PF than it has historically,” Chan said. “Overall, the trend with these proposed amendments is more disclosure for more managers.”
Amendments to the Advisers Act are also on the table
Proposed changes to the Advisers Act include:
- Prohibitions on charging fees or expenses related to a portfolio investment on a non-pro rata basis
- Additional disclosure requirements for fund performance, liquidity and key events at the fund
- Increased disclosure about certain material business relationships in the secondary sale process
- Annual review of compliance policies and procedures
“It’s important to highlight that these, at the moment, are just proposed amendments,” Chan said. “We’ll see, over the coming weeks and months, if these proposed amendments get taken forward and made into formal rules. But, I think we can confidently say there’s a pretty clear trend toward more regulation, more disclosure, and more process and procedure around operating private funds and being a private fund manager.”
There’s a growing problem in the universe of side letters
One of the more essential areas and documents where the work related to these SEC regulations stems is with individual investor side letters. Managers today need to deal with more complex side letters and an increasing number of side letters per fund, along with the increased regulatory scrutiny.
“Managers have expressed a real desire to get ahead of the regulatory curve and start putting robust systems in place to make sure they’re complying with not only the things the SEC requires of them today but will be requiring of them in the future,” Chan said.
What’s the best solution for managers to get ahead of the curve? Chan pointed out an ideal solution needs to allow managers to:
- Centralize contract data to view all commitments made to investors across all funds in one direction
- Quickly understand and benchmark all versions of legal provisions to increase negotiation leverage
- Assign ownership and create workflow-driven activities to fulfill contractual commitments and deliver on promises
- Accelerate audit responses through a comprehensive audit trail of all actions taken to satisfy investor promises
