What Do the SEC’s New Private Fund Disclosure Rules Mean for Investor Communications?
The Securities and Exchange Commission (SEC) voted today to adopt highly anticipated set of rules that increases the disclosures required by private funds, including hedge funds, private equity, and venture capital. The private fund industry has spent the past year-and-a-half fiercely pushing against the changes that were first introduced in February 2022 and would have a substantial effect on how these funds engage with their investors (also known as Limited Partners or LPs). The industry contends that the new rules are redundant with those already in place and may slow growth, ultimately raising costs for investors.
The rules and amendments adopted today cover a wide range of activities that the SEC says are designed to enhance private fund investor protection. New requirements for funds include providing investors with quarterly statements about fund performance, fees and expenses, and that each fund receives an annual professional financial statement audit. Funds have 18 months to comply with the audit and quarterly statement rules.
This vote doesn’t mean the story is finished, however. The new rules will almost certainly face court challenges by various parties, including interest groups aligned with the private fund industry.
In the meantime, this period of limbo represents an opportunity for funds to distinguish themselves to LPs in an increasingly competitive market by emphasizing the transparency they already embrace in their investor engagement. At the same time, investor relations teams can educate the market about how additional expenses resulting from the new rules would affect operations, and potentially fees.
Lean Into Transparency
According to prior Edelman research, 81% of LPs say that “transparency across all aspects of its operations positively impacts their trust in PE firms that they are considering for investment.” It’s not surprising, then, that many funds are already providing at least some of the information that the new changes make mandatory.
Some of the public comments submitted to the SEC contend that longstanding market forces incentivize fund managers to provide reporting, both standard and customized, to investors. Moreover, under an existing regulatory requirement commonly referred to as the “Custody Rule,” many – if not most – private funds are already required to obtain an independent audit of fund financial statements at least once per year.
By highlighting existing disclosure practices, funds can reassure LPs that they have a pre-existing commitment to transparent reporting.
Emphasize Points of Alignment
The investor community is not in universal agreement with the SEC on these changes either. Several large LPs – as well as the Institutional Limited Partners Association (ILPA) – have noted that some aspects of the proposal could, in effect, reduce some of the customized disclosures that they rely on, such as pro rata investor reporting.
Where possible, investor relations teams should stress these areas of alignment and assure LPs that the fund will work with LPs to evolve reporting to ensure that all their needs are still being met. Part of that would likely include transparency on potential new fees if the new reporting requirements result in higher costs for the fund.
Contextualize the Discussion
Pending litigation will keep these issues in the news for the foreseeable future. Numerous comment letters note that these costs will be particularly burdensome to smaller and first-time funds that have fewer resources and are disproportionately owned by women and racial/ethnic minorities.
These rules are also predicted to slow growth in the private fund market, which would have ripple effects across the economy. A 2018 study by the Milken Institute’s Jakob Wilhelmus and William Lee emphasizes the role of private capital in driving innovation across the economy and how that role would be altered if capital becomes more costly.
Fund managers who receive questions from investors about the new rules should look at those moments as opportunities to underscore their awareness and understanding of the potential ramifications for the broader market and newer fund managers.
Align with Peers
Multiple industry groups also have raised the potential effects of these changes on the private fund industry, including the American Investment Council and Managed Funds Association. Funds that are members of these groups should leverage the resources and message coordination that they offer in these situations. Most funds will not publicly comment on the proposals, but they should be aware of what is being said on behalf of the entire industry. Investor relations teams should be prepared to answer any incoming questions, particularly as litigation is filed.
The conversation around the rule changes adopted today is far from over, but funds must carry on even with a lack of regulatory certainty. Fund leaders should explain that they are providing all the information necessary about the fund’s management – and will continue to do so regardless of the outcome of any future litigation. These messages will be particularly useful during fundraising, where potential investors will certainly be asking questions about the new rules.
Senior Vice President