As the Securities and Exchange Commission looks to promulgate new rules on private fund advisers, the scope of potential actions appears wide. Private equity could face new requirements to report the details of GP-led secondary transactions and key management turnover among other triggering events. Today we turn to a former SEC enforcement official for clarity on which rules are most likely to survive the public comment period.
“Many of these rule proposals will get enacted close to what is written,” says 21-year SEC veteran and Kroll’s head of financial services compliance Ken Joseph. “For example, I believe the audit requirement will be passed; most advisors are doing that anyway.”
The agency’s ongoing 60-day public comment period has drawn an influx of responses from industry players in near unanimous disapproval of the proposed regulations, arguing to modify or remove most proposals. At stake is an increase in the compliance burden registered and even unregistered fund advisers will face, a potentially steep increase in in-house or outsourced legal and accounting duties that could eat into profitability.
“You also have to look at it in the context of flurry of rule proposals that could have an impact on advisers of all stripes, registered or unregistered,” Joseph says, pointing to the SEC’s guidance on pending changes to cybersecurity regulation, Form PF filings, and climate change. “The regulatory environment will become more rigorous, potentially increasing the cost of compliance.”
There is “also some collateral litigation risk: certain rules if proposed will lower the bar for investors to bring suit against investment advisers and therefore, again, increase the costs and economics of operating in the private funds space,” Joseph reasons.
But Joseph is not optimistic that the financial services industry’s opposition, however well-reasoned, will succeed. Political considerations could restrict the timing of the review process, foreclosing an economic analysis many fund managers argue is needed to buttress the SEC’s claims that reforms are necessary.
The least controversial reforms are likely to become regulation. A proposed rule requiring even unregistered advisers to disclose annual reviews, for instance, is logical and may be less controversial. Information including fees, expenses, conflicts, compensation the adviser is getting by related persons may need to be disclosed. Also likely to make the final draft are prohibitions on accelerated monitoring fees and changes on reimbursement or indemnification for certain liability based on negligence.
Despite the industry’s uproar, it is a bit striking that fund advisers posting record profits only a quarter ago could really feel much pain from an uptick in compliance costs. Limited partners rarely see a prospectus that highlights efficiencies from internal fund costs, after all. So how much of a bite could additional hours of paperwork really have into private equity?
Here, the story is one of smaller advisers, Joseph says. Emerging fund managers may not have the resources to bear the costs, which could play a role in favoring incumbents. Still, there’s also something to be said for larger funds opposing regulations seen as too onerous as well.
“The more successful advisers, their view is or ought to be is that compliance done right adds to the bottom line,” Joseph says. “It keeps you out of regulatory or investor litigation.”