What You Need to Know about the SEC’s Proposed New Rules for Private Equity Firms

The Securities and Exchange Commission (SEC) recently approved a proposal that would introduce new rules and tighten existing reporting requirements for private equity firms. The proposed new rules represent a significant and complex shift in the regulatory landscape for private funds and institutions.

The proposal aims to “enhance the regulation of private fund advisers and to protect private fund investors by increasing transparency, competition, and efficiency in the $18-trillion marketplace,” according to the SEC’s press release.

Once the regulations have been finalized, the SEC is expected to provide firms with a one-year transition period before enforcement. During this time, firms will have the opportunity to familiarize themselves with new requirements under the proposal, in addition to reviewing existing documentation for disclosure and making the necessary adjustments.

Barring any significant developments, private equity firms should be prepared to integrate best practices for compliance with the regulations contained in the proposal. Adequate preparation on behalf of firms and fund managers will be essential not only to mitigate the risk of penalty or litigation, but also to secure a competitive advantage through proactive adaptation to an evolving regulatory landscape.

In this article, we provide a brief overview of the SEC’s proposal, and what the new rules and requirements could mean for private equity firms going forward.

The Proposal

The SEC’s move comes following an extended period of massive growth in the private sector, which now boasts 1,000 private companies valued at over $1 billion, a significant jump from the 513 recorded in 2020, according to CB Insights. While younger companies and startups increasingly rely on investments from private equity and venture capital funds, one concern among regulators is that the current lack of disclosure requirements could ultimately reduce the number of companies willing to list on public exchanges in the form of a traditional IPO, effectively limiting benefits to the wealthiest investors and institutions. Additionally, the SEC hopes the proposed amendments will provide further protections for investors as well as companies that receive the bulk of their funding from the private sector.

The proposal also comes as no surprise to the private markets, and had been foreshadowed by a semiannual rulemaking agenda in addition to comments made by SEC chairman, Gary Gensler, in January.

“We’ve long had both public companies and private companies,” Gensler told CNBC, “and we’ve said, if you want to tap into the broad public [for capital], there’s a basic bargain: Share information, disclose information that’s important to that investor.”

Such additional disclosure requirements are in fact contained in the official proposal, including the obligation for private funds to provide quarterly statements to investors for the purpose of increasing transparency. The information that will need to be disclosed in the statements includes details related to the fund’s ongoing performance, fund fees, manager compensation, and expenses, all of which intend to allow investors to ensure that funds are not in violation with their governing agreements.

The proposal also contains an exhaustive list of prohibited activities for fund advisers, such as seeking reimbursement or indemnification, charging certain fees without the delivery of agreed-upon services, borrowing or receiving credit from fund participants, and providing preferential treatment to individual investors without disclosing such treatment to the existing client base as well as prospective investors.

Perhaps most notably, the new rules add to the already extensive auditing and tax reporting requirements for SEC-registered private fund advisers. More specifically, advisers will no longer be able to utilize the “surprise audit” alternative provided for by the Custody Rule. They will  be required  to obtain a financial audit performed by an independent public accountant on an annual basis, covering financial statements related to all funds under an adviser’s management. Upon completion, audits must then be “promptly” disclosed to relevant fund investors and the SEC, however the proposal does not currently provide further clarification on a specific timeframe for disclosure.

How Anchin Can Help

Importantly, what we have outlined is merely an overview of this shift in the regulatory landscape for private funds and institutions. Over the course of the next year, private equity firms must continue to familiarize themselves with the broader proposal, ensuring they are optimally structured for tax purposes and in compliance with new accounting regulations. Our auditing services will help you mitigate risk by delivering accurate reporting while staying on time and on budget. Whether your needs require fund-level management, M&A transaction support, portfolio company optimization or exit planning and readiness, we’ll help you create comprehensive solutions to maximize value in and across your portfolio.

For further information on how the new disclosure rules may affect your private equity firm, please reach out to your Anchin Relationship Partner.