#92 VC Reg & Legal Change - The Updates

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VC Regulatory & Legal Change - The Updates

Last week, we wrote about regulatory and legal impacts on VC funds and funds of all types (#90 VC Regulatory & Legal Change Coming). We flagged insights from one of our favorite legal and regulatory experts, Chris Harvey.

He wrote a post titled Regulatory Leviathans that we highly recommend checking out where he shares the following takes: “New Regs Are Coming! • Breaking Down the VC Fund Regulatory Framework • Why the Advisers Act is the SEC's Most Powerful Tool • Summary of PFA Rules for VCs”

Takeaways from Last Week’s New SEC Regulations for PE/VC/Funds

Last week on Wednesday, August 23rd, the final PFA rules were passed! As our friend Chris Harvey noted in a great post on LinkedIn, one way to describe these new rules: RESTRICTED, but not PROHIBITED.

One major reversal is removing the no-GP indemnification rule, but otherwise the final rules are substantially similar to the proposed rules for VCs, EXCEPT most can now be WAIVED by informed written CONSENT from or DISCLOSURE to your LPs. This is a watered down version of the proposed rules, but nudges GP compliance through written disclosures and informed consent.

“All in all, not the worst thing that could happen to VCs and based on what was proposed. It just requires more diligent planning and negotiating with LPs. I think many can deal with this (at least until the next round of proposals)!”

The new rules require that all private fund advisers: â—Ź Prohibit engaging in certain activities and practices that are contrary to the public interest and the protection of investors unless they provide certain disclosures to investors, and in some cases, receive investor consent; and â—Ź Prohibit providing certain types of preferential treatment that have a material negative effect on other investors and prohibit other types of preferential treatment unless disclosed to current and prospective investors

Want to Go Deeper - More Detailed Takes & Insights

  1. Restricted Activities Rules:

    1. Investigation Fees (similar to proposal but waivable by informed consent): No charging or allocating investigation-related fees or expenses to the private fund without disclosure and consent from investors. Fees related to investigations resulting in sanctions for violations are also prohibited.

    2. Regulatory Fees (similar but waivable by disclosure): Advisers can't charge regulatory, examination, or compliance fees or expenses without disclosure to investors.

    3. GP Tax Clawbacks (similar but waivable by disclosure): Cannot reduce the amount of an adviser clawback by certain taxes without disclosing the pre-tax and post-tax amount to investors.

    4. Non-Pro Rata Charges (similar to proposal but waivable by consent): Fees or expenses related to a portfolio investment must be allocated on a fair and equitable basis, and the adviser must provide advance written notice of non-pro rata charges.

    5. Borrowing or Credit Extensions (similar to proposal but waivable by consent): GPs are prohibited from borrowing or receiving an extension of credit from a private fund client without informed written consent.

  2. Preferential Treatment Rule:

    1. Redemptions: Prohibits preferential terms to investors regarding redemptions from the fund, unless required by law or offered to all investors.

    2. Information About Portfolio Holdings: Cannot provide preferential information about portfolio holdings or exposures, unless it is offered to all investors.

    3. Preferential Treatment Disclosure: All terms of preferential treatment must be disclosed in advance of an investor’s investment and all terms disclosed after the investment.

  3. Legacy Status:

  • The SEC is allowing legacy status for the prohibitions part of the Preferential Treatment Rule and the parts of the Restricted Activities Rule requiring investor consent. This applies to governing agreements that were entered into prior to the compliance date, eliminating the need to amend these agreements.

  • These rules collectively aim to address conflicts of interest and protect investors by ensuring transparency, fairness, and equity in the relationships between private fund GPs and investors.

Earlier this week, the SEC released its Final Rule on Private Fund Advisers and Documentation of RIA Compliance Reviews. The Final Rule drives some key themes for private fund regulation:

  • Fundamental shift in treatment of private funds under SEC regulation - the Advisers Act is no longer just a disclosure statue

  • The ERA definition continues to be eroded

  • Most significant change is fee/expense reporting requirements

  • Disclosure requirements increased

  • Potential for litigation to rule given untested statutory authority

The private funds rule - what are the SEC's objectives? One interesting point about the text of the final rule is the addition of three explicit categories which outline the pillars on which the SEC's actions rest:

1) Lack of Transparency. "Private fund investments are often opaque, and advisers do not frequently or consistently provide investors with sufficiently detailed information about the terms of the advisers' relationships with funds and their investors.

2) Conflicts of interest...."many of the problems raised by the conflicts of interest commonly present in private fund adviser practices"

3) Lack of governance mechanisms. "The governance structure of a typical private fund is not designed to prioritize investor oversight of the adviser and general partner or investor policing of conflicts of interest".

In essence, the SEC is saying that investors - even sophisticated, large allocators - have not had enough transparency to oversee their investments in PE and similar funds. That transparency is needed because of multiple conflicts of interest, and a lack of independent governance structures that can hold managers to account.

That’s all for today folks! Thanks for your support and spreading the word! Share this on Twitter or LinkedIn to help grow “the crew!”