SEC Signals Increased Scrutiny of Private Funds

Gensler’s ILPA Summit Remarks

Gensler reminded his audience of the absence of a regulatory framework around private funds until the Dodd-Frank Act of 2010 (the Act), when many private fund advisers had to register with the SEC for the first time. That Act, he noted, gave the SEC additional authority to seek investment adviser disclosures and prohibit investment adviser conflicts of interest, sales practices, and compensation schemes contrary to the public interest and investor protection, and required reporting of private fund holdings to the SEC through the new Form PF. 

Gensler noted that the SEC has learned much about these funds and their advisers from Form PF reports and from SEC examinations, and expressed his view that it is time to take stock of the rapid growth and changes in the field “to bring more sunshine and competition to the private fund space.” 

Gensler highlighted the following specific areas of focus in his remarks:

• Fee and Expense Transparency – A key point of the speech promoted “additional transparency around fees and expenses to fund investors.” Gensler observed that although there have been reductions over time in fees of registered investment funds and index funds, private fund fees have not reduced comparably. He noted transparency issues, particularly where private funds layer multiple levels of fees – e.g., consulting fees, advisory fees, monitoring fees, servicing fees, transaction fees and director’s fees – and requested recommendations from the SEC staff “to bring greater transparency to fee arrangements.”
• Side Letters – Gensler expressed concern about preferential liquidity and disclosure terms in side letters. Conflicts related to side letters is a perennial area of interest for the SEC.⁴ Gensler asked the staff for recommendations on ways to level the “playing field” among investors and strengthen transparency, including whether to prohibit certain side letter provisions.
• Performance Metrics – Gensler contrasted the abundance of available material on mutual fund performance with the lack of such information on private funds. He asked the staff to consider ways to enhance transparency for private fund performance metrics, principally to provide a more meaningful comparison between private funds and public markets.
• Fiduciary Duty and Conflicts of Interest – Gensler acknowledged that limited partners are concerned about private fund general partners seeking waivers of their fiduciary duty at the state level, noting that 48% of institutional investors reported that general partners had modified or reduced their fiduciary duty in new capital allocations. He underscored that federal fiduciary duty cannot be waived. Gensler asked the staff for recommendations to address conflicts of interest and consider prohibitions on certain conflicts and practices.
• Form PF – Gensler recommended that the staff consider “whether more granular or timelier information would be useful” to regulators. Gensler noted that the SEC is working on potential joint rulemaking on this issue with the Commodity Futures Trading Commission, as well as with partners at the Financial Stability Oversight Council, the Department of the Treasury, and the Federal Reserve. 

Fee Calculation Risk Alert

The Risk Alert addressed observations of practices typical of advisers to retail investors, but the deficiencies and takeaways from the Risk Alert also serve as reminders to private fund advisers. The staff observed deficiencies with respect to adviser’s fee calculations, disclosures, policies and procedures, and financial statements. The EXAMS staff encouraged advisers to revisit their written policies and procedures, fee billing processes, established resources and tools, and recording processes for compliance with relevant rules and regulations regarding advisory expenses and fees addressed to and from clients.

Our Take

Gensler’s remarks outline multiple intended areas of SEC focus on private funds during his administration with implications for exams, rulemaking, reporting and enforcement. His remarks, together with the Risk Alert, indicate that the SEC is prioritizing transparency and integrity of fees and expenses. In addition, Gensler indicates broader focus on investment adviser fiduciary duty, suggesting that some investment advisers’ practices may be so contrary to their duty of care and loyalty as to constitute a violation of their federal fiduciary duty, even with full disclosure. 

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¹https://www.sec.gov/news/speech/gensler-ilpa-20211110
²https://www.sec.gov/files/exams-risk-alert-fee-calculations.pdf
³https://www.sec.gov/news/testimony/gensler-2021-05-26