The ‘Costly Burdens’ of the SEC’s New Private Fund Advisers Rule

The U.S. Securities and Exchange Commission announced in August that it had adopted a set of new rules and amendments related to the regulation of private fund advisers.

The SEC noted in an Aug. 23 press release that the “new rules and amendments are designed to protect private fund investors by increasing transparency, competition, and efficiency in the private funds market,” a characterization rejected by industry trade groups that argue the rules will harm private capital investors and reduce their returns.

Analysis by law firm Latham & Watkins shows that the new rules require, among other things, that private fund advisers supply investors with quarterly statements with detailed information about fees, expenses, compensation and performance; and that they provide investors with an annual audit for each private fund managed by the adviser. The rules also stipulate new disclosure requirements and restrict the ability of fund managers to charge or allocate certain fees and expenses to investors.

The rule was published in the Federal Register in September. Parts of it are slated to go into effect in September 2024, and the remainder will be implemented six months after that.

The American Investment Council (AIC), which advocates on behalf of private equity, is among the industry trade groups that oppose the new rule. AIC CEO Drew Maloney said in a press release, “If the Rule takes effect, it will discourage competition, harm investors, reduce returns, stifle innovation, and impose costly burdens on funds of all sizes.”

On Sept. 1, AIC announced that it is joining a lawsuit against the SEC, arguing that the agency’s “attempt to restructure the business arrangements of private funds is unlawful, unwarranted, and ultimately harmful to investors.” The National Association of Private Fund Managers, National Venture Capital Association, Managed Funds Association, Alternative Investment Management Association and Loan Syndications and Trading Association are also participating in the lawsuit.

Middle Market Growth spoke with AIC’s Maloney about the impact of the new rules, the lawsuit and other developments that could affect private capital investors.

Middle Market Growth: What impact will the SEC’s new Private Fund Advisers Rule have on private equity?

Drew Maloney: Ultimately, the new rule will increase costs on all participants, and particularly small and midsize firms due to the higher compliance costs.

If you’re a larger firm, you have a huge team to meet the compliance needs. If you’re a smaller firm, you have one or two people, and then you outsource parts of it. The new requirements will place an increased cost burden on smaller firms. Several economists noted in the comment filings that that the rule will result in a lower number of firms participating in the market because it’s just harder to get up and get started with these new requirements in place.

There were also several requirements in the new proposed rules that we think would be very difficult for firms to meet, such as the quarterly reporting. There is also confusion over preferential treatment and how to work with your limited partners. We believe that several of the provisions are unworkable.

MMG: How will the rule affect midsize businesses?

Maloney: One of the fears is that the rule will disproportionately affect emerging fund managers and smaller firms. If you then have less capital at those lower levels—because it’s harder to create a firm and comply with these rules and regulations—then you’re going to have less capital flowing into the marketplace to fund businesses. I think that’s been the big concern.

One of the fears is that the rule will disproportionately affect emerging fund managers and smaller firms.

MMG: How is the American Investment Council responding to the new rule?

Maloney: There was a broad and unprecedented coalition of business groups, including AIC, that all joined together and filed suit against the SEC. Our briefs are due in the Fifth Circuit in early November, and the SEC will likely respond in early December.

We anticipate oral arguments in the first couple of months of 2024 and the decision at some point in the first half of next year. That’s well before the 12-month first deadline for parts of the rule to go into effect, although firms are still going to have to anticipate that, and they’ll have to comply. We’ll be creating compliance systems to try to meet these requirements.

MMG: The lawsuit alleges that the SEC lacked the authority to pass this rule. Can you explain why?

Maloney: We have argued, and we will argue in court, that the SEC went beyond its statutory authority. Several members of Congress also agree with that position.

In creating this rule, the SEC largely relied on a provision in the Dodd-Frank Act of 2008 that was designed for retail markets and not for the general partner and limited partner audiences.

That’s one provision the SEC relied on from a statutory basis. The second was an anti-fraud provision. However, they didn’t outline any fraud that had been committed. Normally in cases of fraud, you have to outline what you’re trying to fix and create a remedy for a harm. And the SEC didn’t outline a harm.

We feel like we have pretty good grounds on the statutory authority angle.

MMG: What’s the best way for our readers and Association for Corporate Growth members to stay up to date on the rule and new developments in the lawsuit?

Maloney: At the American Investment Council, we focus on the regulatory and legislative environment, so our website is a great resource. And if someone reading this is not a member of AIC, they should consider joining. It’s really a smart way to stay on top of regulatory and legislative issues that could affect your fund or investment portfolio.

For example, we recently hosted a CCO working group meeting in New York with over 100 participants who discussed the new rules and how to comply with them.

MMG: Are there other pending rules or changes that could impact private fund operations or compliance that you and your team are tracking?

Maloney: There are several other rules that will impact how funds and the industry operate. For example, as part of their antitrust oversight, the Federal Trade Commission and the Department of Justice are looking at modifying merger guidelines as well as Hart-Scott-Rodino Act filing regulations. That could have an impact on M&A and how growth funds operate going forward.

In addition to the SEC’s new rule, that’s among the other things that could impact the private fund business model and something we’re tracking closely.

Katie Maloney is ACG’s content director, based in Chicago.