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ILPA seeks SEC rulemaking mandating GPs share deficiency letters with LPs

Sharing deficiency letters is one aspect of a bill introduced in 2019 called the Investment Adviser Alignment Act that has been backed by major institutional investors.

Institutional Limited Partners Association wants the SEC to set minimum standards for several high-level issues in private equity, including calling for GPs to share regulatory examination findings with limited partners who request the information.

Specifically, examination findings are set out in what are called “deficiency letters,” which the agency delivers to private equity firms after completing regulatory exams on their operations and books.

“It would be great if deficiency letters were shared with the limited partners. Right now, the general partners make it very hard to actually see this information,” an LP told Buyouts. “Transparency is a good thing.”

Sharing deficiency letters is one aspect of a bill introduced in 2019 called the Investment Adviser Alignment Act that has been backed by major institutional investors. The bill also calls for minimum standards for the industry including ensuring GPs can’t contract to a lower standard of care than that under the Investment Advisers Act of 1940 and requiring quarterly fee and expense reporting to all LPs. It also would require more open communications among LPs in a fund.

The bill may have more chance of passage in the Democrat-controlled Congress. However, ILPA believes the SEC under President Joe Biden could make rules implementing certain of the provisions in the bill, according to Chris Hayes, senior policy counsel at ILPA.

“We will encourage [the new SEC chair] to consider taking action to establish minimum standards in the industry,” Hayes said.

Biden nominated former Goldman Sachs executive Gary Gensler as the next SEC chairman. Gensler formerly worked as chairman of the Commodity Futures Trading Commission under President Barack Obama. Gensler will go through the rigorous Senate confirmation process to determine if he’ll actually get the job.

SEC deficiency letters generally only contain recommendations for minor fixes but can also include major regulatory breaches. There is no standard industry practice for whether GPs share the letters with their LPs. Some GPs provide summaries of such letters; others ask LPs to come onsite to view the letters.

And some GPs will only alert LPs that they have received deficiency letters without going into detail, sources have told Buyouts in recent interviews.

The Investment Adviser Alignment Act calls for GPs to, upon request, share communications between the agency and the GP related to examinations, inquiries or enforcement actions, as well as provide notice to all LPs about these situations.

“A lot more GPs are sharing the contents of deficiency letters with LPs, but the letters are not being posted to data rooms (during fundraising) or distributed,” a regulatory source told Buyouts in a prior interview. “If you want a high-level summary, you have to do it over the phone, or do it on site. If you didn’t know enough to ask, [many] GPs aren’t going to volunteer it.”