As Industry Continues to Unpack SEC Reforms, Questions Remain about How to Interpret its Intricacies

On September 6, ILPA’s Neal Prunier was joined by Teacher Retirement System of Texas’ Heather Traeger and K&L Gates’ Mark Heine for a webcast discussion on the SEC’s new Private Fund Advisers (PFA) Rules. The webcast provided members with a high-level overview of the new regulations, and how this will affect LPs and private markets at large.

To kick off the conversation, Prunier provided an overview of the rule release.

The sweeping final rule:

  • Reshapes key areas of interaction between LPs and GPs, representing advances in governance, transparency and alignment of interests
  • Introduces a higher minimum standard for required transparency and engagement, including mandated LP consent in certain cases, across key areas such as quarterly fee and expense reporting, quarterly performance measurement, annual financial statement audits, continuation funds, treatment of certain fees and expenses and clawbacks
  • Scales back certain elements relative to the original proposals, while others present some ambiguity in how negotiations will ultimately be impacted, particularly with respect to side letters

ILPA provides additional detail, including a rule by rule analysis, in a series of overview documents available now on the ILPA website.

Key takeaways from the webcast discussion

In addition to going through the basics of each element of the rule of importance for LPs, the webcast guests provided insight on many of the lingering questions ILPA and the industry are grappling with as they work through the intricacies of how it is interpreted and eventually implemented.

The PFA rule will affect LPs and will have application in certain areas to existing funds.

Under the PFA rule’s definition of “providing legacy status,” several of the rules will “not provide legacy status,” meaning the rules will apply retroactively to existing funds. This designation applies to quarterly statements, annual audits, adviser-led secondaries, the disclosure-based restricted activities and the pre-closing/post-closing disclosure portion of preferential treatment. While helpful for the rules to apply the higher minimum standard to existing funds, there are open questions about the costs to provide the required transparency for funds launched over 10 years ago, as well as the practical application for this with terms provided in side letters in existing funds.

Some of the most substantial changes coming out of the PFA rules were discussed in the webcast, including new requirements around reporting fund-level expenses, adding fund-level performance measures to quarterly reporting, and new guidelines around preferential treatment that impact LPACs and side letter negotiations (although to what extent remains to be seen due to ambiguity in language).

Certain language used in the PFA rules is ambiguous, leaving room for interpretation by the industry

Several terms within the new rules are unclear and undefined, leaving lingering questions about what they mean and how they might apply. For example, many in the industry are seeking clarification around the terms ‘material, negative effect’ as used in the preferential treatment section of the rule. ILPA is working to seek clarification on these terms and other undefined sections from the SEC and industry more broadly.

Many participant questions focused on clarifying how the rules will affect secondaries and co-investing. Although the definition of certain terms remains unclear, speakers anticipated that the majority of the rules will apply to secondaries, fund-of-funds, and co-investments.

With no strict guidelines on how to interpret the intricacies of the PFA rule, there are concerns that GPs may take an overly conservative view

The PFA rules have several loosely defined terms, giving GPs the opportunity to interpret certain clauses in their favor. This could have an adverse impact on LPs if they are put in a position where they may bear the costs associated with the new rules.

GPs are preparing a lawsuit to vacate the PFA rules entirely

Currently, the anticipated lawsuit from GPs has been filed in a conservative federal appeals court, with GPs asking the court to hold this rule unlawful. If the court decides to take this case and sides with GPs, it is anticipated the SEC will appeal to the Supreme Court. If the Supreme Court also rules in favor with GPs, or decides not to take the case altogether, the PFA rule in its entirety will not go into effect.

ILPA will continue to operate as though the rule is headed toward implementation, and seek opportunities to work directly with GP organizations to avoid unintended consequences and continue to diligently address issues of LP-GP alignment, as it has done for more than two decades.

Looking ahead

In the weeks to come, ILPA will provide members with additional materials and webcasts offering:

  • A deeper dive into particular rules and topics to identify more directly the impact on LPs – such as preferential transparency, side letters, fiduciary duty and reporting
  • Analysis into anticipated implications on negotiations and experience of LPs during the life of the fund
  • ILPA is also reviewing its various resources, such as the ILPA Reporting Template and the Subscription Line Document, to see how they compare with the rules. If necessary, ILPA will develop a template that meets the needs of the SEC and goes a step further to include reporting LP level performance
  • A review of the timeline and what to expect as we get closer to implementation – especially given the volume of rules that will impact existing funds (without requiring repapering)

Watch a Replay of the Webcast

Contributors: Kassidy Jeansonne

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