The Institutional Limited Partners Association is taking its case national, calling on the Securities and Exchange Commission to update its rules around marketing and fee disclosure and enhance other reporting and disclosure requirements in the name of investor protection.
ILPA chief executive Steve Nelson said in an April 30 letter to SEC Chairman Jay Clayton titled Re: Strengthening the Private Equity Market Through Balanced Oversight that it was addressing key issues being discussed by the regulator, including the advertising rule and disclosure of assets under management by large PE firms.
ILPA argues that the advertising rule, which was last amended in 1961, should be changed for improvement in transparency on the “true cost” of a PE investment. ILPA called out the burden of additional fees and expenses incurred and charged to the LP over the length of the investment, which includes fees and expenses charged to portfolio companies in the fund. It notes as an example that when projected performance in a PE fund investment is presented to prospective LPs, actual fees and expenses to be charged are factored into that prospective performance calculation. The true and total cost of investment “is often elusive today,” ILPA wrote.
The group also opposes any initiative in removing any sections from Form PF, which collects various data points on private equity firms – such as borrowings and liabilities – that could be useful reference points for prospective limited partners. ILPA supports a requirement that Form PF be shared with LPs investing with GPs, saying that members almost never receive that information despite requests for it. ILPA also provided several reasons to retain Section 4, including the use of the data in analyzing risk and how that information would help the SEC’s staff target their examinations on GPs effectively.
As for other cases, ILPA supports the SEC providing more clarity in broker-dealer registration when it relates to PE fund advisers. It pointed to the 2016 case of Blackstreet Capital Management, which charged fees for brokerage services to PE funds they advised but failed to register as a broker-dealer. ILPA said there’s no need for a GP to be registered as a broker-dealer, but the GP should not be allowed to generate fees that do not benefit the LPs involved in capital raising if the SEC grants no-action relief.
ILPA also supported retaining the Custody Rule, which verifies the holdings claimed by an advisor, in its present form and not making any changes because part of the SEC’s guidance includes setting an annual surprise examination on the advisor.
Efforts for regulation reform on the national scale are underway. In 2016, the House of Representatives passed a bill to amend the Investment Advisers Act of 1940 and to modernize certain requirements relating to investment advisors, including changes to the advertising rule. The Senate, though, did not pass the bill, known as the Investment Advisers Modernization Act of 2016.
Some PE firm executives echo ILPA’s push for changes but disagree on some points.
“I agree with the need to modernize the advertising rule and other requirements to today’s realities and the particulars of our industry so as to better align with and protect our investors without creating unnecessary costs or work,” said Joshua Cherry-Seto, chief financial officer of Blue Wolf Capital, a middle-market private equity firm.
“I supported the Modernization Act legislation which championed similar themes. Although we don’t agree with all of the specifics of ILPA’s suggestions, our firm and similar middle-market private equity managers through industry groups have shown we are interested in continued dialogue with the SEC and ILPA on changes that are accretive to our investors,” he added.
California became the first state to require GPs to disclose their fees and expenses charged to LPs. Other states are considering following the Golden State’s lead. Illinois, for example, established a bill that would require GPs to disclose certain fees and expenses to public pension funds. Movement on that piece of legislation, though, has stalled.
But while states may be taking action on their own, ILPA believes that setting a national standard for GPs to follow would be the preferred route so as to avoid GPs having to comply to different reporting requirements by state.
When asked as to why ILPA sent the letter to Clayton, the group says that it is working to address key issues in the best interests of its members ahead of rulemaking decisions. ILPA and some members met on March 27 with two commissioners and the head of the SEC’s Division of Investment Management, which monitors private funds and investment companies, to share their concerns.
“The letter encapsulates a lot of the themes we’ve articulated over the last year or so in meetings with the Commission. But it also points to some specific proposals that are under consideration now from a rulemaking perspective,” said Jennifer Choi, managing director of industry affairs for ILPA. “We wanted to make sure that the limited partners’ point of view on such changes was fully represented, and that any impacts, positive or negative, to the institutional investors are being well considered.”
Christopher Carofine, a spokesman from the SEC public affairs office, declined to comment on ILPA’s letter.
The SEC faces its own challenges internally even as it seeks to be pro-active in monitoring private funds and investment companies. The full-time headcount at its Division of Investment Management is projected to slip to 175 in 2019 from 182 in 2017, according to its 2019 budget presented to Congress.
For that fiscal year’s budget the SEC wants to restore those seven positions to the division, including one that is expected to improve oversight of private funds, their investment advisors and business development companies. That position would help analyze Form PF data and enhance the unit’s ability to respond to requests from private funds on interpretation of advice.
Still, the investment management division’s officers face a huge workload of reports, contracts and portfolios for review. For 2019, the regulator predicts reviewing only 25 percent of an estimated 52,750 filings, the same ratio estimated for 2018. The SEC also forecasts 1,205 formal and informal requests for guidance in 2019, which is about the same amount as its 2018 projection.
As of September 2017, there were 12,616 SEC-registered investment advisors, of which about 37 percent provided investment advice to private funds with gross assets of about $11.6 trillion.
ILPA represents over 450 institutions with more than $2 trillion in PE assets under management. Its members come from over 50 countries and include public and private pension funds, insurers, university endowments and sovereign wealth funds.