IAA Opposes SEC Private Fund Advisers Proposal; Offers Alternatives

April 28, 2022

---

On April 25, the IAA submitted comments on the SEC’s sweeping proposal for private fund advisers, largely opposing the proposed package of regulations that radically departs from the SEC’s longstanding and recently-reaffirmed principles-based approach to the Advisers Act. The proposed rules would ban certain activities by private fund advisers and also impose overly prescriptive requirements on these advisers. While we support increased transparency and addressing investor protection concerns, we believe that the proposed approach to the Advisers Act is unwarranted and unnecessary and that the SEC has not sufficiently justified this significant shift from how it has traditionally regulated investment advisers.

As we note in our letter, we believe that the SEC already has the tools it needs to address its policy goals without imposing prescriptive one-size-fits-all requirements that would allow little flexibility for tailoring to the particular facts and circumstances, be unduly burdensome for advisers and potentially costly for investors, and have other potential unintended consequences. Indeed, we believe that the SEC has significantly underestimated the potential impacts of this proposal and has provided insufficient time for thorough comment and consideration. We ask the SEC that, if it proceeds, it consider several more reasonable and less restrictive alternatives, including, for example, that it require that an adviser have policies and procedures reasonably designed to ensure that the adviser is making good-faith judgments about what is fair and equitable under the specific facts and circumstances.

Our concerns and recommendations regarding the proposal include:

• Prohibited Activities Rule: Indemnification/Limitation of Liability. The SEC proposes to ban limitations of liability clauses for negligence in advisory contracts with private funds, which we strongly oppose. We agree that advisers may not purport to waive their fiduciary duty under the Advisers Act, but we cannot agree that advisers should be unable to limit their liability or be indemnified for negligence in their reasonable and good faith management of a private fund.
• Other Prohibitions. The SEC would also ban a private fund adviser from: (i) charging certain specified fees and expenses; (ii) reducing the amount of an adviser clawback by the amount of taxes; and (iii) borrowing from a private fund client. In our letter, we urge the SEC to address its concerns on fees, expenses, allocations, and borrowings through a more tailored approach involving disclosure and consent rather than prohibitions. We also oppose the prohibition of adviser clawbacks for taxes, which could put advisers in a worse after-tax position than if no investor-protective clawback provision had been included at all.
• Preferential Treatment Rule. The SEC would prohibit private fund advisers from providing “preferential” terms to certain investors regarding redemption or information about portfolio holdings or exposures. Other terms that the Commission considers preferential may be permitted if disclosures are provided. We oppose this ban as unworkable and note that the SEC significantly underestimates the complexity of the proposed provision. We offer alternatives that in our view would be more practicable, investor favorable, and still achieve the SEC’s goals.
• Private Fund Quarterly Statement: Fund (Fee) Table, Portfolio Investment Table, Performance. The SEC would require private fund advisers to deliver to investors and prospective investors a quarterly statement of fees and expenses paid by the fund and its portfolio investments, as well as performance information specified for “liquid” funds and “illiquid” funds. We do not support the prescriptive distinction between “liquid” and “illiquid” funds and performance metrics. Instead, we recommend that the SEC permit funds to use the existing Form PF “gross and net performance” as reported to current and prospective investors. We also recommend that the SEC extend its proposed 45-day deadline to 60 days with longer periods for fund of funds. We make several other recommendations that will allow advisers more time, reduce complexity, and better reflect current investor-beneficial market practices.
• Private Fund Audit Rule. The SEC would require an audit of all private funds annually and upon liquidation by a PCAOB-inspected auditor. We are concerned that the SEC’s proposed audit requirement will effectively amend the Advisers Act Custody Rule without sufficient notice and comment. Instead, the SEC should propose amendments as part of a holistic review of the outdated Custody Rule and provide adequate time for stakeholder feedback on the rule as a whole.
• Adviser-Led Secondary Transactions Rule. The SEC would require private fund advisers to obtain a fairness opinion in connection with an adviser-led secondary transaction. We recommend alternatives to reduce the complexity and costs of the proposed requirement.
• Written Annual Compliance Review. The SEC proposes to require all SEC-registered advisers – not just private fund advisers – to document their annual reviews under the Compliance Program Rule. We support this proposal as most advisers already do so as a best practice.

Finally, and importantly, we urge the SEC not to apply the rules retroactively because doing so would be unfair and unduly burdensome to investment advisers and investors, neither of which would be able to enforce negotiated contractual provisions.

The letter – as with many recent IAA comment letters – was submitted on a very short deadline. Earlier this month, we joined 24 other trades in a letter to SEC Chair Gary Gensler taking issue with the numerous concurrent 30-day comment deadlines and calling on the SEC to provide a more reasonable time for stakeholder input. That effort follows an earlier letter submitted by 13 trades (including the IAA) calling for an extension of the private funds and Form PF proposals.

The IAA also recently published an op-ed in InvestmentNews arguing that if regulators want meaningful feedback, they should bring back 60-day comment periods. We hope these efforts will bear some fruit as the SEC continues to move forward with its ambitious rulemaking agenda.

The private fund adviser comment letter, as well as our other letters, is on our website under Issues & Advocacy/Comment Letters.

We encourage you and your colleagues to get involved in the IAA’s comment letter workstreams.