As expected, 2022 has already seen unprecedented regulatory activity by the Securities and Exchange Commission (“SEC”) related to the private equity fund industry, with at least one rule proposal affecting the industry being released each month this year. Much of that activity has centered around the five areas of Chair Gary Gensler’s agenda that we highlighted in our 2021/2022 Private Equity Year-End Review and Outlook:
- Amendments to Form PF: On January 26, 2022, the SEC proposed significant amendments to Form PF, which we discuss further below.
- Updates to Rules Related to Private Fund Advisers: On February 9, 2022, the SEC proposed extensive new rules that could substantially change the regulation of private fund advisers, also discussed below.
- Climate Change Disclosure: On March 21, 2022, the SEC proposed an extensive climate disclosure rule applicable to public companies. The proposed rule would add new climate-related disclosure requirements to Regulation S-K, which governs qualitative disclosures, and to Regulation S-X, which governs financial statements. If adopted, the proposed rule would constitute a significant expansion of SEC disclosure requirements related to climate change.
- Rules Related to Investment Companies and Investments Advisers to Address Matters Relating to Environmental, Social and Governance Factors: New rules setting forth ESG-related requirements for investment companies and investment advisers are in the works and expected to be released in the second quarter of 2022.
- Revisions to the Definition of Securities Held of Record: This potential amendment to the definition of “held of record” for Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”) could result in private fund portfolio companies and funds having to file public reports under the Exchange Act.
In addition, as discussed below, the SEC has proposed a new rule governing SPACs, and, as discussed elsewhere in this issue, a new rule regarding cybersecurity measures that registered investment advisers must implement. Further, the SEC intends to propose, or re-propose, rules targeting the exempt offering framework under the Securities Act of 1933 and rules specific to Regulation D under that Act.
Updates to Rules Related to Private Fund Advisers
On February 9, 2022, the SEC proposed extensive new rules which, if adopted, would substantially affect private fund advisers. Notably, many of the proposed rules, which would require specific disclosures and prohibit certain commercial terms, cover all advisers to private funds, rather than just registered investment advisers. In our view, the adoption of these rules may result in increased management fees, as private fund advisers seek to recoup the higher cost of compliance, insurance and reporting. Given that these proposed rules represent a significant shift in the regulation of private fund advisers, we expect them to generate numerous comments both in support and in opposition.
The proposed rules include the following prohibitions and requirements that would cover all advisers to private funds:
- Prohibition of Certain Indemnities: Investment advisers would be prohibited from seeking indemnification or from limiting the adviser’s liability for breach of fiduciary duty, willful misfeasance, bad faith, negligence or recklessness in providing services to the private fund.
- Restrictions on Carveouts from GP Clawback Provisions: Tax-related caps on GP clawback provisions would be prohibited.
- Prohibition on Certain Fees and Expenses: Investment advisers would be prohibited from charging certain fees and expenses, including those associated with services not provided, an adviser’s regulatory or compliance matters, or an adviser’s examinations and investigations.
- Prohibition on Non-Pro Rata Cost Allocation: The proposed rules would prohibit an adviser from charging fees and expenses related to portfolio investments on a non-pro rata basis among clients.
- Prohibition on Borrowings from Private Funds: Advisers would be prohibited from borrowing from, or receiving an extension of credit from, a private fund.
- Prohibitions on Preferential Treatment (Side Letter Terms): The proposed rules would prohibit private fund advisers from: (1) providing preferential terms to certain investors regarding information about portfolio holdings or exposures or redemptions from the fund and (2) providing other preferential treatment, including treatment that is sometimes required by state and local laws, unless disclosed to all current and prospective investors.
These prohibitions and requirements would only cover registered investment advisers to private funds:
- Requirements Related to Adviser-Led Secondaries: Before closing on an investment in an adviser-led secondary transaction, registered investment advisers would be required to obtain and distribute a fairness opinion to investors from an independent opinion provider. They would also be required to prepare and distribute a written summary to investors of material business relationships between the adviser and the opinion provider in the previous two years before closing.
- Quarterly Statements: Registered investment advisers would be required to provide fund investors with quarterly statements detailing information about the private fund’s performance, fees and expenses within a certain timeframe (i.e., within 45 days after the end of each quarter).
- Annual Audit from an Independent Public Accountant: Registered investment advisers would be required to distribute audited financial statements annually and upon liquidation. Advisers would also need to enter into a written agreement with the independent public accountant overseeing the audit requiring the auditor to notify the SEC if the audit report contained a modified opinion. The agreement would also require the auditor to notify the SEC upon the auditor’s termination, dismissal, resignation or removal from consideration for being appointed.
- Written Annual Compliance Review: The proposed rules would require registered investment advisers’ annual compliance reviews to be documented in writing.
The comment period for this proposal originally ended on April 25, but it was reopened to 30 days from the related announcement’s publication in the Federal Register. For more information on the above requirements, please see our key takeaways and comprehensive summary of the proposed rules here.
Amendments to Form PF
The proposed amendments to Form PF, which were adopted pursuant to the Dodd-Frank Act of 2010, would also affect private fund advisers, most notably by instituting one-day reporting requirements for certain key events and by establishing additional reporting requirements for a broader group of private fund advisers. The proposal also added requirements for large liquidity fund advisers. Taken as a whole, the Form PF proposal would add burdensome reporting requirements on private fund advisers without a corresponding increase in investor protection benefits. The proposals also do not appear to advance the systemic risk-monitoring goals of the Dodd-Frank Act.
The comment period for the proposed rule ended on March 21. For more information on these amendments, please see here.
Amendments Relating to SPACs and de-SPAC Transactions
On March 30, 2022, the SEC proposed new rules and amendments to enhance disclosure and investor protections in initial public offerings by special purpose acquisition companies (“SPACs”). Of special note to private fund advisers are the amendments related to the status of SPACs under the Investment Company Act of 1940 (the “1940 Act”). Specifically, proposed Rule 3a-10 under the 1940 Act would provide a safe harbor exemption from the definition of “investment company” under Section 3(a)(1)(A) of the 1940 Act for SPACs that meet certain conditions.
The SEC has requested comment on the proposed rules by May 31, 2022 or 30 days after publication of the rules in the Federal Register, whichever is later. The proposed rules are subject to a 60-day public comment period. For more information on these amendments, please see our summary here.
Cybersecurity Rule Proposal
Additionally, on February 9, 2022, the SEC proposed rules related to cybersecurity compliance for registered investment advisers. They would include a requirement to confidentially report certain cybersecurity events to the SEC.
The comment period for the proposal ended on April 11. For more information on this proposal, please see our Four Takeaways from the rule proposal here.
Climate Change Disclosure Proposal
On March 21, 2022, the SEC released its long-awaited proposed rule applicable to public reporting companies on the “Enhancement and Standardization of Climate-Related Disclosures for Investors,” which is intended to require “consistent, comparable, and decision-useful information” on climate-related disclosures. The proposed rule would add new, often prescriptive climate-related disclosure requirements to Regulation S-K, which primarily governs qualitative disclosures, and Regulation S-X, which governs financial statements. In general, these disclosures would address various climate-related risks to the registrant’s business, operations, and financial condition, including disclosure of a registrant’s greenhouse gas emissions. The proposed rule could affect public portfolio company investments of private equity funds (or private company investments that a sponsor intends to take public), as well as private equity managers that themselves are public companies.
The SEC had originally requested comment on the proposed rule by May 20, 2022, or 30 days after publication of the rule in the Federal Register, whichever is later, but extended it to June 17. For more information on these amendments, please see our summary here.
As noted above, we expect the SEC to continue to propose (and re-propose) rules at a rapid pace throughout the remainder of the year. Coupled with focused examination initiatives and continued enforcement of private fund advisers, 2022 will continue to be a period of intensified U.S. regulatory activity affecting private equity advisers and the investment management industry.