US regulators’ planned private-equity overhaul has received rave reviews from most institutional investors. But some still see a few rough edges in the proposal.
The Securities and Exchange Commission in February proposed a massive slate of new rules for private funds that would require detailed new disclosures of fees and expenses while banning certain practices.
Among the proposals is a rule that would require firms to disclose details of side letters — documents that spell out agreements between a fund manager and one of its investors to alter certain terms of a fund for that specific investor.
The private equity industry has come down hard on the proposal. Meanwhile, investors in private equity funds have generally cheered the proposal.
Jennifer Choi, managing director for industry affairs at the Institutional Limited Partners Association, a trade group that represents institutions that invest in private equity, talks about how its members see the rules.
This interview has been edited for clarity and brevity.
Chris Cumming: The SEC’s proposal incorporates several changes that ILPA has long been asking for. What role, if any, did ILPA play in influencing the proposal?
Jennifer Choi: We did not have a direct role in shaping this proposal. We had engaged with the commission in 2021, anticipating the likelihood that there would be a proposal specific to fee and expense disclosure, in line with comments chair [Gary] Gensler had made. We submitted letters laying out the nature of the rule proposal we thought would be best aligned with the interests of LPs.
CC: Does the regulator’s proposal on fee and expense disclosures go far enough, or too far?
JC: We believe what the SEC proposed is consistent with what we advocated for in 2021. As we said in our response to the proposal, the framing of the proposal around fund-level disclosures would elevate the floor in cases where these are not being provided today.
In cases where managers have negotiated some other arrangement regarding fee and expense transparency, we don’t feel like those arrangements should be obviated by this rule. We felt the proposal could be improved by requiring managers to make LP-level disclosure available to the investors that request it. But the fund-level requirement the SEC has proposed would certainly improve the quality of disclosure for those LPs that receive very little information today.
CC: Some LPs have expressed reservations about the requirement that managers disclose all side letters to all investors. Why is this a concern?
JC: There is a broad spectrum of views on this proposal and the topic of side letters generally. I believe LPs share pretty strongly the view that side letters are essential to their ability to invest in private funds.
There are some institutions where this is non-negotiable, meaning that if they can’t get a guarantee their investment will exclude certain sectors or companies, they can’t invest.
There is also a range of views on how helpful disclosure truly is in terms of influencing strategy or provisions with a particular manager. Part of the concern comes from the notion that LPs would be receiving all this info, but not necessarily in a format or time frame that allows them to act upon it.
But it does impose costs, because individual LPs would have to pay their counsel to go through those disclosures. There is a concern that if transparency is forced beyond what is decision-useful and actionable, the cost and complexity will be borne by LPs.
CC: How do you view the argument from private equity lobbying group the American Investment Council that the SEC disclosure proposals are unnecessary because investment terms are negotiated by sophisticated investors?
JC: Specific to disclosure and leaving aside other aspects of the proposal, it’s true that LPs with meaningful relations with GPs and significant negotiating capital are able to arrive at arrangements where the necessary disclosures are being provided.
That is not universally true for all LPs. So I think that the assertion that LPs are sophisticated and can negotiate for what they want belies the fact that there are many LPs, including very large, very sophisticated LPs, who would tell you that they are making necessary choices and trade-offs in what they negotiate for.
This article was published by WSJ Private Equity Pro, a fellow Dow Jones Group title