The SEC’s Latest Proposals Could Significantly Impact Private Equity Funds

March 9, 2022

Over the past few weeks, the SEC issued two sets of proposed rule amendments which, if passed in their current form, could greatly impact the regulatory and operational landscape for private equity funds:

Proposed Amendments to Form PF
Proposed Rules for Private Fund Advisers

The following summarizes each of the material rule proposals that are particularly relevant to private equity funds (given their typical structures and methods of operation):

  • Form PF Reporting Frequency for Certain Events – Private equity fund advisers would be required to file current reports within one business day of the occurrence of the following events pertaining to the: execution of adviser-led secondary transactions, implementation of general partner or limited partner clawbacks, removal of a fund’s general partner, termination of a fund’s investment period, or termination of a fund. Currently, Form PF requires advisers to file Form PF after their quarter- or year-ends, depending on the size and type of private funds they advise.
  • Large Private Equity Adviser Reporting Threshold – The proposed amendments would reduce the threshold for reporting as a large private equity adviser from $2 billion to $1.5 billion in private equity fund assets under management. This would bring more advisers under the reporting regime.
  • Large Private Equity Adviser Information to be Reported – The proposal would require large private equity advisers to report more information regarding fund strategies, use of leverage and portfolio company financings, controlled portfolio companies (“CPCs”) and CPC borrowings, fund investments in different levels of a single portfolio company’s capital structure, and portfolio company restructurings or recapitalizations.
  • Private Fund Adviser Prohibited Activities – All advisers to private funds would be prohibited from, among other things:
    • (1) Reducing the amount of any adviser clawback by actual, potential, or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders. Currently, most clawback provisions contain a “net of taxes” concept – this would be particularly relevant to private equity funds with American style waterfall provisions; and
    • (2) Seeking reimbursement, indemnification, exculpation, or limitation of its liability by the private fund or its investors for a breach of fiduciary duty, willful misfeasance, bad faith, negligence, or recklessness in providing services to the private fund. Most private equity funds presently contain a “gross negligence” standard.
  • Preferential Treatment – Any adviser to a private fund would not be permitted to grant an investor favorable redemption terms that the adviser reasonably expects could have a material, negative effect on other investors. While not common, if a private equity fund were to actually grant a special liquidity right to an investor, this provision would be implicated. In addition, a private fund adviser would not be allowed to provide any preferential treatment to any investor in the private fund, unless the adviser provides written notices to both prospective and current fund investors that contains specific information regarding the preferential treatment. Since many private equity funds enter into side letters, this would greatly change the dynamic of that process.
  • Adviser-Led Secondaries – It would be unlawful for any SEC-registered investment adviser to complete an adviser-led secondary transaction with respect to any private fund, unless the adviser (1) obtains, and distributes to investors in the private fund, a fairness opinion from an independent opinion provider and (2) prepares, and distributes to investors in the private fund, a written summary of any material business relationships the adviser or any of its related persons has, or has had within the past two years, with the independent opinion provider, in each case, prior to the closing of the adviser-led secondary transaction. An “adviser-led secondary transaction” means any transaction initiated by the investment adviser or any of its related persons that offers private fund investors the choice to: (a) sell all or a portion of their interests in the private fund; or (b) convert or exchange all or a portion of their interests in the private fund for interests in another vehicle advised by the adviser or any of its related persons.
  • Quarterly Statement from Registered Investment Advisers – A quarterly statement would need to be delivered to private fund investors within 45 days of each quarter-end by SEC-registered investment advisers containing a Fund Table, a Portfolio Investment Table and certain Performance Reporting:
    • (1) The Fund Table would require disclosure of fees and other compensation to the adviser and its affiliates, fees and expenses of the private fund and, of particular relevance to private equity fund advisers, the amount of any offsets or rebates carried forward during the reporting period to subsequent periods to reduce future payments or allocations to the adviser or its related persons.
    • (2) The Portfolio Investment Table would require disclosure of the ownership of and the investment compensation generated (e.g., origination, management, consulting, monitoring, servicing, transaction, administrative, advisory, closing, disposition, directors, trustees or similar fees or payments) from covered portfolio investments. Covered portfolio investments mean portfolio investment that allocated or paid the investment adviser or its related persons portfolio investment compensation during the reporting period.
    • (3) Performance Reporting would also need to be presented relating to illiquid fund performance in the following manner without the impact of any fund-level subscription facilities: (a) gross IRR and gross MOIC for the illiquid fund; (b) net IRR and net MOIC for the illiquid fund; (c) gross IRR and gross MOIC for the realized and unrealized portions of the illiquid fund’s portfolio, with the realized and unrealized performance shown separately; and (d) a statement of contributions and distributions for the illiquid fund.