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US regulators impose tougher disclosure rules on private funds

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US securities regulators have adopted an ambitious reform package that significantly reshapes the way the $27tn private funds industry deals with its investors.

The Securities and Exchange Commission voted on Wednesday to require private equity, venture capital and hedge funds to provide investors with detailed quarterly reports on performance and increased disclosure on expenses. It also put new limits on secret side deals that give better terms to some investors.

The package, approved by a 3-2 vote, marks the most sweeping changes in more than a decade for a lightly regulated and rapidly growing global industry that serves pension funds and universities and is increasingly looking to work with wealthy individuals. Since 2012, the number of private funds has more than tripled to more than 100,000.

“Economically, our investors, large or small, benefit from greater transparency and integrity,” SEC chair Gary Gensler said after the vote. “These are significant enhancements in the capital markets.”

Industry groups have lobbied furiously against the proposals since they were first put forward in February 2022, saying institutional investors should be free to make their own deals with fund managers. They contended that tighter regulation will stifle innovation, raise expenses and force investors and fund managers to tear up tens of thousands of existing contracts.

The rule “is unnecessary government interference . . . [that] will squelch competition in the name of enhancing it,” said Hester Peirce, a Republican commissioner who laid out many of the industry’s objections to the rule before voting against it. “The market has not failed.”

The final package dropped or modified some of the proposals that most worried the industry. Notably, it eliminated changes to fund liability rules that would have allowed investors to sue for “negligence” rather than “gross negligence”. It also substituted disclosure requirements for outright bans on some preferential treatment and some controversial fees.

The SEC rule also adds an element of “grandfathering”, which will mean some contracts can stay intact, and phases in most requirements over a one- to two-year period.

The commission pushed ahead with required quarterly performance reports with standardised metrics that will make it easier to compare funds.

It also banned the practice of giving some investors favourable redemption rights and additional information about fund holdings, unless they are offered to everyone. The SEC will also require disclosure or explicit investor consent when funds want to pass on compliance costs.

“This is industrial policy. The SEC wants to be much more involved in the oversight of these institutions,” said Brian Daly, partner at Akin.

The new rules would impose “significant costs” and big changes on the industry, said Elizabeth Shea Fries, partner at Sidley. “This is trying to make private funds more like registered funds.”

Financial reform groups and Democratic lawmakers praised the SEC for taking steps to regulate private funds but some criticised the agency for softening some of its original proposal in the face of criticism.

“These rules will help protect workers’ pensions and create a more transparent and accountable private funds market,” said Senator Sherrod Brown, who chairs the banking committee.

But Stephen Hall, legal director of Better Markets, said, the final rules “fall short of what’s necessary to protect investors from the appalling array of unfair, predatory and opaque practices.” 

Fund industry groups, which had threatened to file suit to stop the draft rules from going into effect, said they were pleased the final rules had taken into account their comments but warned they still had concerns.

“We will be focusing on its potential to stifle innovation and harm the economic environment for venture and start-ups,” said Bobby Franklin, chief executive of the National Venture Capital Association.

Jack Inglis, chief executive of the Alternative Investment Management Association, said: “The rules adopted today still contain several areas of concern . . . we will be discussing our options.”

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