Stricter disclosure regulations imposed by US regulators for private funds

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US securities regulators have implemented a comprehensive reform package that brings significant changes to the way the private funds industry, worth $27tn, interacts with its investors.

The Securities and Exchange Commission (SEC) voted on Wednesday to mandate private equity, venture capital, and hedge funds to provide detailed quarterly reports on their performance and increase transparency regarding expenses. The SEC has also implemented new restrictions on undisclosed agreements that offer preferential terms to certain investors.

This package, approved by a 3-2 vote, represents the most substantial changes in over a decade for an industry that provides services to pension funds, universities, and wealthy individuals. The private funds industry has experienced rapid growth, with the number of private funds more than tripling to over 100,000 since 2012.

“From an economic standpoint, both small and large investors benefit from improved transparency and integrity,” stated SEC chair Gary Gensler after the vote. “These are significant enhancements for the capital markets.”

Industry groups have vigorously opposed these proposals since their introduction in February 2022, arguing that institutional investors should have the freedom to negotiate individual agreements with fund managers. They claim that tighter regulations will stifle innovation, increase costs, and require the renegotiation of thousands of existing contracts.

Hester Peirce, a Republican commissioner who voted against the rule, stated that it is “unnecessary government interference” that will hinder competition rather than enhance it. She also said, “The market has not failed.”

The final package has made changes to some of the industry’s most concerning proposals. Notably, it eliminated alterations to fund liability rules, which would have allowed investors to sue for “negligence” instead of “gross negligence.” The SEC also replaced outright bans on certain preferential treatment and controversial fees with disclosure requirements.

The SEC rule includes a “grandfathering” provision, allowing certain contracts to remain unchanged. Most requirements will be phased in over a one- to two-year period.

The commission is moving forward with mandatory quarterly performance reports using standardized metrics to facilitate fund comparisons.

The rule prohibits the practice of granting selective investors favorable redemption rights and additional information about fund holdings, unless such privileges are offered to all investors. The SEC will also require disclosure or explicit investor consent for funds passing on compliance costs.

“This represents industrial policy. The SEC aims to have greater oversight of these institutions,” said Brian Daly, a partner at Akin.

Elizabeth Shea Fries, a partner at Sidley, stated that the new rules will impose “significant costs” and substantial changes on the industry. She added, “This is an attempt to make private funds more similar to registered funds.”

Financial reform groups and Democratic lawmakers praised the SEC for its efforts to regulate private funds, although some criticized the agency for diluting certain aspects of the original proposal in response to criticism.

“These rules will safeguard workers’ pensions and establish a more transparent and accountable private funds market,” said Senator Sherrod Brown, chair of the banking committee.

However, Stephen Hall, legal director of Better Markets, argued that the final rules “do not go far enough to protect investors from unfair, predatory, and opaque practices.”

Fund industry groups, who had threatened legal action to block the draft rules, have expressed satisfaction with the final rules taking their comments into account but cautioned that concerns still remain. Bobby Franklin, CEO of the National Venture Capital Association, stated, “We will focus on the potential impact on innovation and the business environment for venture capital and startups.” Jack Inglis, CEO of the Alternative Investment Management Association, added, “The adopted rules still have several areas of concern…we will explore our options.”