US SEC approves proposal to adopt broad disclosure rules for private investment funds

The US Securities and Exchange Commission (SEC) took another step closer this week towards its aim to provide greater oversight of private funds. On February 9, 2022, the SEC approved and passed, by a three to one vote, a proposal requiring private equity and hedge funds to provide basic disclosures to their investors and guard against conflicts. This proposal comes less than a month after the SEC announced proposed disclosure rules aimed at obtaining more information from private equity and hedge funds to help regulators better spot risks in private markets, which we discussed in this previous legal update.

If approved, these proposed disclosures would not have to be filed with the SEC or made public. Instead, private funds would generally be required to maintain books and records to allow regulators to assess their compliance with the rules. Additionally, the proposal identifies and prohibits a myriad of activities related to private funds with the aim of addressing what the SEC perceives as a "lack of governance mechanisms" by private fund advisers. Under the proposal:

• Private fund managers would be required to prepare quarterly statements including certain information regarding fund performance, fees, expenses, as well as manager compensation and distribute it to their investors within 45 days after each calendar quarter-end.
• Private funds would have to undergo annual, independent audits in an effort by the SEC to place a check on asset-valuation estimates often used to calculate fund managers’ fees.
• Private equity and hedge fund advisers, including those not registered with the SEC, would be prohibited from engaging, directly or indirectly, in certain sales practices, conflicts of interest and compensation schemes that the SEC perceives as contrary to the public interest and the protection of investors. The prohibited activities include the following:
  
  

• Charging fees for certain unperformed services
• Charging certain private fund and portfolio investment fees—such as accelerated monitoring fees and fees and expenses related to a portfolio investment—on a non-pro rata basis when multiple private funds and other clients advised by the adviser or its related persons have invested (or propose to invest) in the same portfolio investment
• Borrowing money, securities, or other fund assets, or receiving an extension of credit from a private fund client
• Seeking reimbursement, indemnification, exculpation or limitation of liability for certain activities
• Reducing the amount of any adviser clawback by the amount of certain taxes
• Granting an investor in the private fund or a substantially similar pool of assets preferential terms regarding liquidity or transparency that the adviser reasonably expects to have a material, negative effect on other investors in the fund or a substantially similar pool of assets
• Providing preferential treatment to any investor in the private fund unless the adviser provides written disclosures to prospective and current investors
• Written notice to a prospective investor in the same fund must be provided before the investor's investment in the fund
• Written disclosures to a current investor in a private fund must be distributed on at least an annual basis regarding any preferential treatment that occurred since the last notice was provided
• Whether a term is preferential will be analyzed and determined based on the relevant facts and circumstances

The proposed amendments will be open for comment for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is later.

Special thanks to Emma Yeremou-Ngah for her assistance in the preparation of this content.