The US Securities and Exchange Commission in May extended the public consultation period for its proposals on the private funds industry. The public was given until mid-June to provide feedback on the regulator’s potential changes to how the industry operates, including on clawback provisions, GP-led secondaries, and how fees and expenses are charged.
Private Equity International caught up with Mayer Brown lawyers Timothy Clark and Adam Kanter the week the extension was granted. Mayer Brown was engaged by the Securities Industry and Financial Markets Association to prepare a response letter, which it sent to the SEC in late-April. Here are a few key areas the letter addressed.
The private markets industry has, over years of evolution, enabled a tremendous ability to negotiate contracts. The SEC’s proposals appear to be overreaching because of this long history of freedom of contract in private markets, the Mayer Brown team argues.
“You have large pension plans and state or sovereign wealth funds cutting cheques for hundreds of millions of dollars,” says Clark. The notion that sophisticated investors who are engaging legal counsel and are negotiating what can amount to 50-page side letters need special protections from the industry is “ridiculous”, he adds.
Difficulty defining GP-leds
The SEC’s proposals cover GP-led secondaries processes, generally understood to be liquidity transactions in which LPs have the option to cash out their LP stakes. Such processes sometimes involve moving assets from an existing vehicle to a continuation fund.
Ascertaining whether a secondaries deal was initiated by the GP or not can be tricky, says Mayer Brown. The term “adviser-led secondary” could have wider-reaching consequences than intended, such as precluding LP stake matching platforms – mechanisms that allow LPs to sell their interests in a fund to a buyer – because the fund sponsor could be deemed to have “initiated” the deal.
Such cases are very typical, especially at the end of a fund’s life, says Clark. “The GP is trying to liquidate the portfolio, but it’s having difficulty. Often there are dribs and drabs that are left at the end. LPs oftentimes do say, ‘can we do something?’”
The lack of clarity around defining GP-leds also raises questions about who should foot the bill for an organised secondaries transaction if it is unclear who initiated it.
Mandatory fairness opinions
Imposing mandatory fairness opinions for GP-led deals is a good example of trying to apply a one-size-fits-all policy to a nuanced issue, the Mayer Brown lawyers wrote. There are certain GP-led transactions that are not conflicted by nature, such as those based on a third-party valuation set by the sale of a minority position, making moot the need for a fairness opinion.
The rule is also specific to private equity and does not account for processes involving liquid or semi-liquid assets.
Increased use of SMAs
The new rules would require that preferential treatment, often enjoyed by the investors that write the largest cheques, be disclosed to current and prospective investors. If such activities are deemed harmful to existing LPs, they could be prohibited altogether.
Trying to define what can and can’t be negotiated could drive LPs away from commingled funds and towards separately managed accounts. This would not only drain money from the private equity funds, but would hurt smaller LPs, says Kanter.
“[Large LPs] are some of the most aggressive commenters on the terms of the fund that apply to every investor in the fund… You could end up with a situation where smaller investors no longer get the benefit of these large investors, which are cutting a big cheque to the fund, negotiating hard against the sponsor to make changes to the fund documents that benefit everyone.”