SEC Chairman Gary Gensler, in testimony before a Senate committee Tuesday, used a term that caught the attention of folks who live and breathe private equity compliance and regulation.
Gensler, who became SEC chair earlier this year after Senate confirmation, said the commission is exploring “reforms” for private funds around conflicts of interest and disclosure of fees.
“I believe we can enhance disclosures in this area, better enabling pensions and others investing in these private funds to get the information they need to make investment decisions,” Gensler said, according to a transcript of his testimony.
“Ultimately, every pension fund investing in these private funds would benefit if there were greater transparency and competition in the space,” Gensler said in testimony before the Senate Committee on Banking, Housing and Urban Affairs. The committee is led by private equity critic Sen. Sherrod Brown.
The SEC under President Biden is expected to take a more aggressive role in regulating and punishing bad practices across corporate America, including private equity.
SEC earlier this year laid out its examination priorities for 2021 that included focusing on GPs giving preferential treatment to certain LPs; portfolio valuations; adequacy of disclosure and compliance with regulatory requirements of cross-trades, principal investments or distressed sales; and conflicts involving GP-led fund restructurings and secondaries deals involving staple components.
Gensler’s use of the word “reform” was significant, according to Igor Rozenblit, the former co-head of the SEC’s private funds unit. Rozenblit left the commission earlier this year and started his own consulting firm called Iron Road Partners.
The commission’s main tool to implement reform is through rulemaking, which could indicate the SEC leaning toward a streamlined process for fee and expense reporting. This could take many forms, including one that looks similar to the template provided by the Institutional Limited Partners Association, Rozenblit said. However, there are other approaches that the SEC is also likely considering, including a principles-based approach.
“I can imagine a couple questions added to the Form ADV about what is a fee and what is an expense,” Rozenblit said. The template could be principles-based, rather than rules-based, defining what is a fee and what is an expense and allowing managers to fill out those categories.
The Financial Reform Act of 2010 put most private equity firms under the scrutiny of the SEC, which compels firms to open their books to the commission for regulatory exams. Private equity firms (with assets of $150 million and more), like all registered investment advisers, are bound by the rules of the 1940 Investment Advisers Act.
New rulemaking would be unprecedented, in that the SEC has relied on regulating through interpretive positions and enforcement actions based on the Act since it formalized its scrutiny on private equity, according to Marc Ponchione, partner with Debevoise & Plimpton’s investment management group. Disclosure of fee and expense practices is, and has been, included on the commission’s examination priorities for this year.
Rulemaking requires a rigorous process of proposing something in public, allowing time for comment, consideration and possible revisions after comments, and if the rule is not abandoned, implementation.
“The tools already exist to police this area,” Ponchione said. “The formal rulemaking process wouldn’t seem to be the proper mechanic to address conflicts of interest [or fees].”
Also, specific rulemaking around private equity fees and expenses was not listed on the commission’s regulatory agenda published in June. So any rulemaking around fee and expense disclosure would come as a surprise, according to Ponchione.