Last week, SEC Chair Gary Gensler gave the keynote speech for the 2021 Institutional Limited Partners Association’s virtual summit. Gensler focused his remarks exclusively on private funds and detailed his view that private equity and hedge funds need more scrutiny and regulation. Careful to differentiate his statements from those of the SEC, he listed the following subjects as areas he expects will receive additional SEC focus in the near term:
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- Fees and Expenses: Chair Gensler advocated for additional transparency regarding private fund fees and expenses which he hopes will lead to greater competition. In particular he referenced the multiple types of fees common in private funds, including management fees, performance fees, portfolio company fees, consulting fees, advisory fees, monitoring fees, servicing fees, transaction fees, director fees, etc.—which, in his opinion, need streamlining or more transparency.
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- Side Letters: Chair Gensler advocated for additional transparency in side letter provisions to support more equality amongst similarly situated limited partners. Importantly, he suggested the SEC is considering prohibiting certain types of side letter provisions. In particular, Gensler focused on side letters that result in preferred liquidity, disclosure, and/or fee terms. Such provisions, he noted, result in “similar pension plans consistently pay[ing] different private equity fees”, a fact which he believes results in an “uneven playing field” among limited partners in a fund—presumably a condition to be remedied by more transparency of side letter terms.
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- Performance Metrics: Chair Gensler advocated for increased transparency regarding performance metrics, including potentially requiring private funds to prepare performance information matching the standardized information already mandatory for mutual funds. The SEC standardized and mandated performance reporting methodology for mutual funds decades ago, while allowing non-standard performance reporting if accompanied by SEC measures of “total return”.
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- Fiduciary Duties: Chair Gensler reminded attendees that under no circumstances, and in no form, can general partners contract themselves out of their federal fiduciary duties under the Advisers Act. There are increasing efforts by general partners to add such provisions to fund documents. It was unclear if Chair Gensler intended to break new ground or was referring to the Commission’s position on standards of conduct (i.e., fiduciary duty cannot be waived “though its application may be shaped by agreement”.) See, IA-5248, footnote 31. https://www.sec.gov/rules/interp/2019/ia-5248.pdf.
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- Conflicts of Interest: Gensler stated an intention to mitigate the effects of conflicts of interest between general partners, affiliates, and their investors. He has asked SEC staff to consider potential prohibitions on specific conflicts and practices, but did not mention any in particular.
- Form PF: Chair Gensler advocated for an update to Form PF to include more granular and/or timelier information in order to strengthen the SEC’s oversight of private fund advisers and better understand private funds’ systemic role in the financial markets in general.
Chair Gensler framed the need for these additional regulations as stemming from a concern for the importance of the key players in the private funds market – (i) institutional investors, including pension plans, foundations, and endowments, on the one side, and (ii) portfolio companies, including start-ups, small businesses, and more established commercial enterprises, on the other—all of whom he believes would benefit from greater government protection and oversight of private funds. Gensler elaborated:
“Private funds touch so much of our economy. So it is worth asking ourselves at the SEC whether we’re meeting our mission with respect to this important slice of the capital markets? Are we protecting investors? Are we facilitating capital formation? Are we maintaining fair, orderly and efficient markets in the middle?”
Chair Gensler apparently believes the answer is “needs improvement”. We note that Chair Gensler’s reference to standards for mutual funds seems instructive as to where the Commission might head during his tenure.
A transcript of Gensler’s entire speech can be found here.
If you have any questions regarding this update, please reach out to Foley’s Investment Management and Fund Formation practice.
