SEC chair Gensler hints at potential further rules for private funds

SEC chairman Gary Gensler, who brands the private funds industry as systemically important, intimated during a Senate hearing this week that more regulations could be on the way for private equity.

The industry “was systemically important 25 years ago when Long-Term Capital Management was teetering on the brink of failure. The field is systemically important today,” Gensler said.

In the wake of the most sweeping regulations since the global financial crisis, Gensler was grilled Tuesday by members of the Senate’s Banking, Housing and Urban Affairs committee about the new rules the SEC finalized in August.

The rules were meant to enhance transparency and disclosure in the private funds market. They would mandate, among other things:

• Quarterly reporting on fees, performance and expenses;
• Annual audits for each fund;
• The same access to info for every LP in a fund;
• Fairness or valuation opinions on GP-led secondaries;
• LP consent to charge the fund for investigations or examinations

During the discussion, Gensler said the SEC is working with other government agencies on other areas of potential enforcement.

Senator Jack Reed (D-Rhode Island) asked Gensler whether more regulation is needed for private fund managers around issues of money laundering and filing suspicious person reports, similar to what banks must do.

“The investment advisers have certain responsibilities with regard to these funds, but we’re in discussions whether there might be important further steps to take, consistent with the Bank Secrecy Act,” Gensler said.

Gensler was referring to potential rules being contemplated by the Treasury Department that would prescribe that certain investment advisers establish anti-money laundering programs and requirements for reporting of suspicious activity to the Financial Crimes Enforcement Network, a source told Buyouts.

Reed also asked whether, because of the massive growth of the private capital markets and the industry’s systemic importance, private fund managers should be subject to similar rules as public companies.

Gensler said that would be up to Congress. “The disclosure we have recently adopted [as] a rule, is just further disclosure to their investors around their fees, their performance, their side letters. But Congress could decide to broaden that out.”

Perspectives at the senate hearing fell along party lines with Republican senators accusing the SEC of overstepping its mandate, and Democrats urging Gensler to do more, especially around issues of climate change and cryptocurrency regulations.

Senator Elizabeth Warren (D-Massachusetts) pressed Gensler to go further in regulating the private funds industry, which she said has eclipsed public markets in America in terms of AUM, but is still much less regulated.

“In other words, the SEC is carefully regulating a public market that handles only about one in four new investment dollars, while almost three out of four dollars are going into a private market that has much weaker rules. Those weaknesses are meaningful even after the rules change,” Warren said.

As an example, Warren said PE firms selling exempt securities don’t have to report audited financial data to the public or disclose information about portfolio company failures.

“It seems to me that’s invitation to fraud,” Warren said. “How do you explain to the American people that the SEC, whose job is to make sure markets are honest, is standing by while private equity and the companies they own scoop up investor money without any public verification that the books are honest or that they aren’t hiding huge risks?”

Gensler countered that the new private funds rules, which the SEC finalized last month, would force registered investment advisers like private equity firms to file quarterly reports on fees, performance and side letters and annual audits of those documents.

On the other side of the aisle, Republicans accused the SEC of stifling economic growth with overregulation. Senator Tim Scott (R-South Carolina) said the SEC’s enhanced private funds rules would “hurt small businesses and push small and diverse fund managers out of the market, ultimately limiting jobs and opportunities for many in the local economy.”

And Senator Chris Van Hollen (D-Maryland) pressed Gensler on risks associated with sovereign wealth funds, especially from China, becoming limited partners in private funds. Gensler said that was out of the SEC’s scope, but the commission is working alongside other agencies on potentially enhancing those protections.

Earlier this month, several industry groups sued in federal court to block the rules.