The new fund marketing rule from the Securities and Exchange Commission, which went into effect on November 4th, probably won’t have a big effect on investors in private equity funds, but it will keep compliance officers busy.

“Regulatory lawyers are working around the clock,” says Molly Diggins, general counsel and partner at Monument Group, a major placement agent adviser. “But it’s not going to affect the industry much.”

The requirement to use only net returns in ads and pitches to new investors, instead of the historic practice of bragging about overall returns, will mean changes in marketing for most funds and a lot of headaches for all compliance officers.

“The rules are more prescriptive,” says Diggins of the 430-page final rule, “but they are not always very clear. The SEC has not provided much guidance.”

Nonetheless, the regulator has indicated there will be a sweep on compliance as a Risk Alert in September promised to focus on it in examinations. The amendments under the Investment Adviser Act consolidate and replace previous provisions on advertising and cash solicitation as well as various no-action letters over the years.

For many private equity funds, using net returns as a selling point has been the best practice anyway. “This is not new,” notes Diggins. “I can’t imagine an investor in a PE fund will be persuaded or dissuaded by this rule.”

The knottiest problem for the funds will be to determine net returns on a deal-by-deal basis since that can be difficult in many projects.

“The SEC did it hoping to get rid of squishiness, but what it does is just require more detail,” says the Monument Group expert.

Some funds may opt to footnote net returns claims on deals, saying this does not necessarily represent reality. Others may choose to ignore the requirement and hope for the best.

For most, “it means a lot more paperwork,” says Diggins. “The key will be to have substantiation for your claims.” Among other things, it means funds will have to ensure compliance from their placement agents.

The commission voted final approval of the rule on December 22, 2020, in the waning days of the Trump administration, just before chair Jay Clayton left office. The long lead time for an effective date means it now falls to the Democrat-majority commission under chair Gary Gensler to enforce it.

But it seems to be right up Gensler’s alley as he zeroes in on greater transparency from private equity funds. Even with a flurry of new rules that many have criticized as unrealistic and burdensome (this is generally a complaint from regulated entities), the SEC shows every sign it intends to enforce this legacy from the previous administration.

“I don’t think it will get lost,” says Diggins. “It’s an important one for the SEC.”

Darrell Delamaide