Private Funds Hit with New SEC Fee Disclosure Rules

Industry groups have said the SEC overstepped its authority under Gensler. The Managed Funds Association recently told members that it could sue the regulator within two weeks of the new regulations being finalized, unless they’re softened significantly from what the agency proposed in February 2022.

Gensler couched the rule as a transparency measure well within the agency’s authority under the 2010 Dodd-Frank Act to prohibit or restrict advisers’ sales practices, conflicts of interest and compensation.

“Consistent with our mission and congressional mandate, we advance today’s rules on behalf of all investors—big or small, institutional or retail, sophisticated or not,” Gensler said in a prepared statement.

“It’s a massive shift for investors,” said Chris Hayes, president of advisory firm RedLine Policy Strategies. “You’re creating a level playing field around negotiating fee transparency for investors.”

The rule also prohibits funds from charging investors fees to cover regulatory investigations and compliance costs, unless investors agree to the costs. It bans funds from charging those fees and expenses if the regulatory actions result in a court- or government-ordered sanction.

“Not only does the rule address a lot of informational gaps investors in private funds have had, it rightfully also goes after some of the most egregious behavior that funds have been able to get away with,” said Andrew Park, senior policy analyst at Americans for Financial Reform, referring to the curbs on those particular fees.

In one significant revision, the SEC plans to scrap a provision that would have made it easier for investors to sue fund managers when wagers sour.

Some of the core measures of the rule remain in place, however. In a bid to crack down on conflicts of interest, the SEC would bar private funds from making any one group of investors shoulder an outsize share of fees beyond their fair share – unless that practice is disclosed.

If firms engineer a type of secondary deal to cash out investors and transfer older positions from one fund to another, they will need an independent auditor to ensure investors are getting a fair deal.

The regulator will, however, allow existing arrangements to remain in effect, rather than forcing funds to renegotiate their deals with investors — a measure pushed for by industry lobbyists.

It’s unclear whether the industry will view the changes in the final version as sufficiently addressing their concerns — or at least enough to stave off a major legal challenge.

“I have significant concerns with using the coercive power of government regulation to favor one side of a private negotiation,” Republican Commissioner Mark Uyeda said in prepared remarks. Uyeda’s dissent is widely viewed as a potential road map for trade groups to sue.

Trade groups and their attorneys will spend the next few days devouring the extensive rule before deciding their next steps. Yet initial reactions indicate persistent concerns.

“MFA continues to have concerns that the final rule will increase costs, undermine competition and reduce investment opportunities for pensions, foundations and endowments,” Bryan Corbett, the trade group’s chief executive officer, said in emailed remarks. He added that the MFA is assessing its next moves, “including potential litigation.”

Any litigation would probably focus on the commission’s first-ever use of its new Dodd-Frank authorities to dictate sales practices and compensation between private funds and institutional investors. A significant amount of criticism from the SEC’s two Republicans and industry groups has focused on whether the regulator can dictate how to structure investment arrangements and whether it should be protecting well-heeled pension funds and endowments.

Gensler, during a call with reporters after Wednesday’s meeting, said the SEC is empowered to protect all investors, not just Main Street traders.

“I feel very confident about the analysis, about the authorities” the rule is grounded on, he said.

Still, industry participants are taking note of his defense of the SEC’s remit.

“It is an unusual thing for the SEC chair to talk about the SEC’s authority, which is an indication the SEC is concerned about the threat of litigation,” said former SEC official David Blass, who’s now a partner at Simpson Thacher & Bartlett.

New era

The changes would mark a new era of regulatory scrutiny for private equity firms, which have rapidly expanded amid lighter regulation and as investors search for higher yields. Many now extend far beyond buyouts and into lending, financing critical infrastructure and funding real estate deals.

Private equity firms and hedge funds typically charge investors fees of about 2% of the money they manage and take a cut of 20% of profits. They also collect other charges from investors and the companies in which they invest.

Since taking office in 2021, Gensler has made bringing more transparency to the $17 trillion industry a cornerstone of his rulemaking agenda. He has argued that its fees are opaque, while its footprints across markets merit heightened scrutiny.

The rule has been in the works for years, with investor groups lobbying lawmakers to impose more disclosure rules on private equity and meeting with President Joe Biden’s transition team to make the case for more regulation.

Separately, the SEC also approved a final rule that would subject proprietary-trading firms to greater regulatory oversight by limiting how many of them can claim an exemption from registering with the Financial Industry Regulatory Authority.

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