SEC Proposes New Rules for Private Funds, Cybersecurity Risk Management

The Securities and Exchange Commission voted to propose new transparency rules for private fund advisers as well as new cybersecurity risk management rules for registered investment advisers.

The regulator said the proposed new rules for private fund advisers are intended to increase transparency, competition and efficiency in the $18 trillion marketplace. It said the rules would require registered private fund advisers to provide investors with quarterly statements that detail certain information regarding fund fees, expenses and performance.

The proposal would prohibit all private fund advisers from providing preferential terms to certain investors regarding redemptions from the fund or information about portfolio holdings or exposures. It also would prohibit all private fund advisers from providing other preferential treatment unless that information is disclosed to current and prospective investors. The SEC said this is intended to prohibit specific types of preferential treatment that have a material, negative effect on other investors.

“The proposed rules address informational gaps and asymmetries, as well as inherent conflicts of interest that can harm investors and markets,” SEC Commissioner Allison Herren Lee said in a statement. “It’s critical to note the large and growing presence of retail investors, and particularly those with retirement assets, exposed to this market,” she added, noting that U.S. pension funds hold approximately $480 billion in private equity investments.

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The proposed changes would also create new requirements for private fund advisers related to fund audits, books and records, and adviser-led secondary transactions. They would also prohibit all private fund advisers from seeking reimbursement, indemnification, exculpation or limitation of liability for certain activity. In addition, the changes would prohibit advisers from charging certain fees and expenses, or from charging fees or expenses related to a portfolio investment on a non-pro rata basis, among other activities.

The SEC also proposed amendments to the Advisers Act compliance rule that would require all registered advisers, including those that do not advise private funds, to document the annual review of their compliance policies and procedures in writing.

Louis Bruno, a partner at EisnerAmper, told CIO that since the financial crisis, institutional investors have been clamoring for private fund management transparency, as well as access to meaningful and accurate data.

“With the private markets experiencing unprecedented growth in recent years, investors will continue to expect more disclosure,” Bruno said, “and private fund managers will need to effectively adapt to meet the new standards to compete for capital in the market.”

Bruno suggested private fund managers review current fee and expense calculations, corresponding policies, and procedures to see if they align with the fund governing documents and investor disclosures. He also said that regarding updating disclosures, fund managers should prioritize consistency, alignment with current practices, and clarity on how fees are calculated and allocated to each fund.

“Fund managers should also consider developing a communication strategy in advance that would provide transparency to investors about expected changes to fees, expenses, financial statements, etc.,” he said, adding that “an inefficient framework provides limited ‘point in time’ risk and often makes it very difficult to implement new regulatory requirements.”

Commissioner Hester Peirce issued a statement saying she would vote against the proposed new rules, calling them a “sea change” that support the “belief that sophisticated institutions and high-net-worth individuals are not competent or assertive enough to obtain and analyze the information they need to make good investment decisions.”

The SEC also voted to propose rules related to cybersecurity risk management for registered investment advisers, registered investment companies and business development companies.

The proposed rules would require advisers and funds to adopt and implement written cybersecurity policies and procedures that are intended to address cybersecurity risks that could harm advisory clients and investors. The proposed rules would also require advisers to report to the SEC on a new confidential form significant cybersecurity incidents that affect the adviser or its fund or private fund clients, and to publicly disclose cybersecurity risks and significant incidents that occurred in the last two fiscal years in their brochures and registration statements.

Additionally, the proposal would establish new recordkeeping requirements for advisers and funds that are intended to improve the availability of cybersecurity-related information and help facilitate the SEC’s inspection and enforcement capabilities.

“The proposed rules and amendments are designed to enhance cybersecurity preparedness and could improve investor confidence in the resiliency of advisers and funds against cybersecurity threats and attacks,” SEC Chair Gary Gensler said in a statement.