Part Two: New Rules, Industry Response, and Implications
Loyola University Chicago School of Law, JD 2025
Welcome back! Part One of this two-part series discussed the regulatory background of private funds and the increasing importance of private funds industry regulation today, particularly for retired and retiring Americans. Part Two of the series takes a closer look at the final new rules implemented by Securities and Exchange Commission (SEC) Chair Gary Gensler. The Chair released the new rules in August affecting private funds advisors and investors. This article also discusses Wall Street’s response to the new regulations and ends with its possible implications for the industry.
What exactly are the new rules?
Chair Gensler stated that the new rules are intended to enhance the regulation of private funds advisors, with the goal of protecting investors through increased transparency, competition, and efficiency in the market. To achieve this end, new rules that apply to all advisors include 1) the Restricted Activities Rule and 2) the Preferential Treatment Rule.
The Restricted Activities Rule
The Restricted Activities Rule prohibits advisors from engaging in some activities unless certain disclosure requirements are met. Those restricted activities include charging private funds for regulatory, compliance, and examination fees or expenses. Prior to the adoption of this rule, the question of whether these fees were charged to the investors was left to the parties to decide. Now, advisors are prohibited from charging investors for these expenses unless the advisor delivers a written notice of any such fees to the investors at least quarterly. Advisors are also prohibited from charging or reallocating fees and expenses related to portfolio investment unequally between investors in the same fund, unless the allocation is considered fair under the circumstances and the advisor discloses to each investor within the fund the non-equitable allocation.
The Preferential Treatment Rule
The Preferential Treatment Rule prohibits advisers from providing certain preferential treatment to any investor in a private fund unless the adviser satisfies certain disclosure requirements. Advisors are prohibited from granting an investor in a private fund more favorable redemption terms on their investments than other investors in the same fund, unless the advisor has offered the same redemption ability to all investors in the fund. Under this rule, advisors are also prohibited from providing an investor information regarding the holdings of a private fund unless the advisor offers the same information to all other investors in the same fund. While the compliance dates for both rules are twelve months from the release date in August, the rules will likely affect fundraising and operations of private funds once effective.
Coalitions representing the largest private funds in the country sued the SEC in federal court in September to block the new rules. The suit claims that the SEC has overstepped its statutory authority to regulate private fund advisors and that the new rules will quash a thriving and entrepreneurial industry worth trillions of dollars.
Plaintiffs include the Managed Funds Association, American Investment Council, National Venture Capital Association, and the National Association of Private Fund Managers. The lead plaintiff, the National Association of Private Fund Managers, was founded last year in Texas after the SEC released its then proposed new rules. This was likely intentional, since the group’s location enabled it to file suit against the SEC in response to its new rules in the Fifth Circuit Court of Appeals. The Fifth Circuit has become a preferred venue for business groups seeking to challenge regulatory powers; there, Republican-appointed federal judges hold a 19-6 majority over Democrat-appointed judges.
The effects of an adverse ruling in the Fifth Circuit may extend beyond just private funds. If the SEC is found to have overstepped its statutory authority under the Advisor’s Act and Dodd-Frank Act (as the lawsuit claims) to regulate private funds through the new rules, then the authority of the SEC to regulate other asset managers and prevent fraudulent and deceptive business practices may also be challenged. This may lead to an avalanche of deregulation in an industry worth trillions of dollars and extending to most corners of our society.
The final new rules themselves are less restrictive than what the SEC initially proposed in February 2022. For example, the Restricted Activities Rule initially proposed a blanket prohibition on charging regulatory, compliance, and examination fees to investors. The final rule now provides an exception, potentially undermining negotiation and compensation schemes between investor and advisor.
Despite being the most comprehensive set of new private funds regulation since the Great Recession, the final new rules considered above stop just short of creating true transformation in the private funds industry. In a space characterized by extended negotiations and complex transactions affecting huge sums of money, strict regulation without loopholes is essential to provide adequate oversight and protect all parties. The huge sums of money and the numerous private funds end up affecting more than just the advisor and investor, after all. Somewhere, there is a public-school teacher or a firefighter whose retirement is implicated in a private fund. The SEC should consider the average person when enforcing private funds regulation. It could be us one day that loses their pension.