The Securities and Exchange Commission’s move to potentially require more disclosure and prohibit some activities by private equity firms is drawing a mixed reaction from the world of alternatives.
The proposal to require private equity firms to share quarterly fund performance data and detailed information on fees was mostly expected, but the SEC has taken private equity firms by surprise by its effort to outlaw some conduct altogether.
One proposal to prohibit advisers from seeking indemnification for breaching fiduciary duty is likely to draw strong opposition, said a lawyer who works on regulatory issues with private equity firms.
“That’s a big deal,” said Jason E. Brown, a partner at Ropes & Gray LLP. “There’s going to be significant industry pushback on that point. That’s the one that will garner the most attention from the industry.”
Brown said the rules in question are also known as hedge clause provisions between private equity firms and their investors. These agreements typically say the private equity firm will be indemnified by the fund for losses it suffers so long it meets the standard of care – with no negligence or gross negligence.
Now, under the proposed rule, that practice is prohibited. That means that a provision that was typically negotiated between investors and private equity fund managers would no longer be allowed.
The rule opens private equity firms up to more risk, Brown said. If losses in a fund take place, and if the private equity manager was negligent and a loss was suffered, its liability can no longer be limited. Under the SEC’s proposal, the private equity firm may not seek indemnification from the fund, regardless of what the fund documents say.
The SEC said the rule change would help protect investors.
“By limiting an adviser’s responsibility for breaching the standard of conduct, the incentive to comply with the required standard of conduct is eroded,” the SEC argued. “We believe such contractual provisions are neither in the public interest nor consistent with the protection of investors, particularly where investors are led to believe the adviser is contractually not obligated to comply with certain provisions of the act or rules thereunder, or where investors with less bargaining power are forced to bear the brunt of such arrangements.”
In terms of the quarterly reporting and performance data, the SEC has been concerned with making sure investors understood fees and expenses.
“The concept that you’ll have to give investors regular reports was expected,” Brown said. “People weren’t expecting the performance data requirement, but most are already doing this anyway with their LPs on a quarterly basis.”
A spokesperson from the American Investment Council (AIC), the lobbying arm for major private equity firms, said the group did not have a prepared comment specifically on the SEC’s prohibited activities proposals.
Overall, the AIC does support more transparency and disclosure with investors.
“We work closely with our investors to ensure they have the information they need to make the best investment decisions,” AIC president and CEO Drew Maloney said in an email to MarketWatch. “We are concerned that these new regulations are unnecessary and will not strengthen pension fund returns or help companies innovate and compete in a global marketplace.
The SEC said it will gather comments for 60 days on the proposed S7-03-22 rules, which would be added to the existing Investment Advisers Act of 1940.