Large LPs start to publicly support SEC’s proposed PE rules

Elimination of preferred treatment could even the playing field but have other consequences.

Major limited partners are publicly endorsing proposed SEC rules meant to enhance transparency and fairness in private equity investing.

Los Angeles Fire and Police Pension System recently publicly supported Securities and Exchange Commission’s rules addressing preferred treatment given to certain LPs when forming a fund. This is accomplished through the use of so-called side letters as part of fund contracts, which carve out special exceptions or side deals with certain limited partners.

In February, the SEC proposed new regulations that would prohibit favorable redemption rights, reduced fees and access to information granted to LPs who make large commitments that is not made available to other investors.

“These proposed rules will significantly increase confidence among institutional investors that fund advisors will act in the best interests of all investors, including by requiring fund advisors to disclose to institutional limited partners like LAFPP when a fund adviser treats certain investors differently, and to analyze the ramifications of that disparate treatment,” wrote LAFPP general manager Raymond Ciranna in comments made to the SEC.

The $31 billion LAFPP allocates $5.9 billion to private market investments, according to Ciranna’s letter.

The SEC’s proposed preferred treatment rules have gained attention throughout the industry, according to several sources. Large LPs tend to use side letters to get special terms as part of the commitment to new funds and to carve out exceptions required for these institutions to make the investments.

“It has a lot of managers and LPs raising their eyebrows and asking, ‘what’s going on here?’” said an attorney on background who works with private equity managers.

Some in the industry say that several preferred treatment practices harm smaller LPs that have less capital to work with than larger pension funds.

GPs can give preferred LPs fee breaks or access to co-investment and continuation fund opportunities that may put smaller investors at a disadvantage, explained another attorney.

“LPs in many respects are direct competitors. We shouldn’t want to live in a world where there are haves and have-nots, and some LPs have a distinct advantage over others,” this attorney said.

But unintended consequences from eliminating preferred treatment rules may occur. For example, one source said GPs will face increased compliance costs to meet new disclosure requirements, which will eventually get passed along to LPs.

“These types of costs could eventually shut smaller LPs out of certain funds or developing relationships with certain managers,” the source said.

As well, some LPs need the ability to be excluded from certain types of investments, like vice-related companies. It’s unclear how those exceptions will be codified without the use of side letters.

While preferred treatment may pit large versus small, at least two of the nation’s largest pension funds said they support the proposed regulations.

“It is imperative that institutional investors are provided with transparency and clear reporting, and this rule strengthens those requirements. The New York City Retirement System is one of the largest pension systems in the country and achieving strong returns while safeguarding the assets of its beneficiaries remains our priority. We are continuing a full analysis of the impact of the proposed SEC changes, and our office is optimistic that they will have a positive impact on the industry,” said New York City Comptroller Brad Lander.

“Every LP should be treated equally. I don’t think any LP based on proportional investment should be treated different than anyone else. For us, it’s not if but when the shoe is on the other foot. Sometimes we’ll be on the $50 million end of a commitment. Sometimes we’ll be on the $500 million end of it. Treating everyone equally is the right thing to do,” said North Carolina Treasurer Dale Folwell, who oversees North Carolina Retirement Systems.