17.10.2023 – 07:02

Regulation: Can the SEC still avoid a confrontation with the private market industry?

Executives at the Securities and Exchange Commission (SEC) had hoped to avoid a confrontation with private funds over regulation of the sector. The new rules, announced in August by the SEC, were hit with a law suit within days of unveiling the updated regime.

At first sight, the Private Finance Adviser Rules appear relatively modest. They impose new requirements on reporting and disclosure, a duty for funds to provide investors with statements on performance, fees, and expenses. So these seem to be good things in the first place. More transparency and reducing information asymmetries between the agents—the Genera Partner and funds managers on the one hand and Limited Partners on the other hand—seem to address the principle-agent problem.

The new rules also restrict funds’ abilities to engage in practices such as offering some investors enhanced redemption rights or preferential rates on fees; funds will only be allowed to behave in these ways if they make appropriate disclosures or, in some instances, seek explicit consent from investors. This again seems to play into market transparency and equal access issues and would reduce principal agent problems.

The SEC argues that this regulation does little more than bring private funds into closer alignment with the rulebook that governs public funds run by banking groups in the US. The regulator also points out that it has made significant concessions following feedback from the private funds industry; the draft rules had envisaged an outright ban on many practices that will now be allowed if investors are told about them or give their permission.

On September 1, six trade associations asked a Texas-based federal appeals court to overturn the new rules. They argue that the cost and restrictive nature of the regulation will stymie growth in the sector, hitting jobs and limiting the amount of capital available to the broader economy. One can really wonder only about the size of these private markets. They have gained tremendously, according to Bain and Company (2021), and make up about 14–15 trillion USD. Privately, private equity and hedge funds express concern that this regulation will prove to be the thin end of the wedge.

The SEC has become increasingly interventionist, they argue, and this regulation is likely to prove to be merely an opening skirmish in a more aggressive incursion into their industry. For interested parties and onlookers, there are now two obvious questions. First, are the SEC’s new rules proportionate and reasonable? And second, does the SEC have the statutory powers to impose this new regime (if not, the answer to the first question is rendered moot)? The debate is waging about whether the SEC has the statuary power to regulate private markets and, if the answer is yes, whether the rules are appropriate.

This is far from clear-cut. The private fund industry points out that its investor base is professional, well-resourced, and well-advised. Investors such as family offices and pension funds have the experience and expertise to manage their relationships with private funds; they understand the pros and cons of different approaches and the need to scrutinise cost and performance. For all these reasons, they do not need to be protected by a regulator in the same way as, say, retail investors, who may be much more vulnerable to exploitation.

The counterargument is that these are different times. For one thing, the private fund sector has grown enormously. The SEC says there are now more than 47,000 funds worth more than $14 trillion registered with it; that’s an increase from only 20,600 funds worth $5.3 trillion a decade ago. An industry of this scale must be held accountable, the regulator and its supporters argue. It has been pointed out rightly that a second argument by the SEC is that the assets managed by the industry do, ultimately, come from retail investors who are protected elsewhere.

Private fund customers such as pension funds, after all, are simply stewards of retirement savers’ money; All eyes are now on Texas’s US Court of Appeals for the Fifth Circuit, widely regarded as a conservative adjudicator.What is your opinion? Should private market funds be more regulated? Let us know.

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Karen Wendt

President of SwissFinTechLadies