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Private funds caught up in SEC chair ’ s unwavering pursuit of transparency
News that the SEC is announcing proposals to enhance fee , cost and performance transparency at private funds should not come as a massive shock to industry watchers – given the regulator has been scrutinising this issue for a long time now .
Since 2015 , fees and expense allocations – especially in private equity – have been an area of intense focus for the SEC , with several high-profile managers being forced to pay compensation to settle allegations of egregious fee practices .
According to one expert , the SEC is looking to root out bad governance practices at private capital funds – especially as it relates to conflicts of interest .
In a particularly damming report released in January 2022 , the SEC identified multiple deficiencies at private funds – including instances of firms providing investors with misleading information about their track records and inaccurate performance calculations together with evidence of managers overcharging fees to clients after disposing of portfolio companies .
Under the new proposals , private funds – managing at least $ 150 million in assets – will be forced to provide clients with quarterly reports containing in-depth information about performance , fees and expenses . In short , fees and expenses paid by the private fund must be clearly itemised , while the disclosures should reference any compensation paid to the GPs ( general partners ) by portfolio companies and details relating to the fund ’ s internal rate of return and investment multiple each quarter .
The SEC is also looking to outlaw a number of industry practices , including banning GPs from charging fees to LPs or portfolio companies for unperformed services such as accelerated monitoring fees .
The regulator is also coming down hard on side letters with proposals to ban managers from offering preferential terms to investors via such structures unless they are fully disclosed to existing and prospective clients .
In addition to demanding greater fee disclosures from alternative asset managers , the SEC is also tightening up on some of its preexisting regulatory reporting obligations . First introduced in 2011 under the Dodd-Frank Act , the Form PF ( Private Fund ) template must be completed by alternative asset managers before being submitted to the SEC and the Financial Stability Oversight Council ( FSOC ) as part of the latter ’ s remit to monitor systemic risk in the US financial system .
Perhaps the biggest change is that the SEC is forcing large ( i . e . $ 1.5 billion plus ) hedge funds and private equity firms to report on so-called ‘ key events ’ within one business day of them happening . This comes as the SEC recognises that a lot of the Form PF data currently being supplied to them on a quarterly or annual basis is often out of date by the time they get a chance to review it . Without any timely information , build-ups of systemic risk or potential mistreatment of investors could go unnoticed by regulators .
According to law firm Sidley Austin , key events for hedge funds would include extreme scenarios such as extraordinary investment losses ( defined as a cumulative loss over a rolling 10 business day period of 20 % or more of the fund ’ s Net Asset Value [ NAV ]); certain margin events ; counterparty defaults ; material modifications to prime brokerage relationships ; changes in unencumbered cash ; redemption requests equalling more than 50 % of the fund ’ s NAV ; and serious operational disruptions .
In the case of private equity , key events include things like sponsor-led secondary transactions ; implementation of a GP or LP ( limited partner ) clawback ; or the removal of a GP . This is likely to pose challenges for some firms .
The proposals – both in terms of client disclosure requirements and the Form PF revisions are still in their early days – but fund administrators are conscious their clients will need solutions .
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