How would the SEC’s proposed disclosure enhancements affect GP-led deals?

The proposal comes as the SEC tightens scrutiny on private equity under chairman Gary Gensler.

The SEC is proposing enhanced disclosure rules that would force private equity managers to report more information about GP-led secondaries deals, as well as LP and GP clawbacks and key-person events.

Gary Gensler

An immediate question is whether the rising activity around GP-led deals will be curtailed by enhanced disclosure requirements of GP-led deals that could trigger an examination.

The rules, which would be required as part of an enhanced Form PF, would be a drastic enhancement of the kind of information private equity managers have traditionally disclosed. But regulators believe more information is necessary to properly understand private equity operations.

The proposal comes as chairman Gary Gensler’s regime puts private equity under tighter scrutiny, with the intention of squeezing more information out of managers that have historically operated without much transparency.

“This is a very significant rule change and gives the SEC a substantial amount of timely information that will feed directly into their exam and enforcement activities”

Igor Rozenblit, Iron Road Partners

The SEC approved the proposal in January, which also included enhanced rules for hedge funds. The proposals will go into a public comment phase before they receive final approval.

“This is a very significant rule change and gives the SEC a substantial amount of timely information that will feed directly into their exam and enforcement activities,” said Igor Rozenblit, founder and partner at Iron Road Partners, a compliance consultancy. Rozenblit formerly co-led the SEC’s private funds examinations group.

The SEC also made additional proposals in early February that cover GP-led secondaries deals, which would mandate the use of independent fairness opinions to ensure the price on a given transaction falls within a “range of reasonableness”.

Gap in the proposal

One gap in the proposal is that the SEC is not mandating that GPs share the information with LPs, according to a LinkedIn post from Chris Hayes, senior policy counsel with the Institutional Limited Partners Association.

ILPA supports the mandated use of the Form PF, which was required by the Dodd-Frank financial reform act in 2010 to track systemic risk in private funds. SEC registered investment advisers are required to file the Form PF each quarter or on an annual basis.

For private equity managers, the proposed rules would require GPs to file current reports within one business day of closing a GP-led deal, implementation of GP or LP clawbacks, removal of a fund’s GP or termination of a fund’s investment period or termination of a fund, according to a fact sheet published by the Commission in January.

Disclosure rules would be enhanced for portfolio companies. GPs would be required to share more information on portfolio companies’ restructurings and recapitalisations, fund investments at different levels of a company’s capital structure, use of leverage and portfolio company financings, the fact sheet said.

There is some pushback around the idea that any of the events mentioned, such as the closing of a GP-led transaction, represent systemic risk.

“Our initial reaction is that we can see no reason for a one-business-day reporting requirement for such events, and we question whether many of these events have any bearing on systemic risk, which is the purpose Congress assigned to Form PF,” said an alert from law firm Simpson Thacher & Bartlett.

“Other proposed one-business-day reporting events focus on extraordinary events, such as a significant margin and counterparty default, which arguably could have a systemic impact in certain circumstances. The events listed above do not appear to meet that criteria, and suggest that the SEC may be seeking to use Form PF for other purposes. This shift of use, alone, should be a cause of concern because the SEC could seek to use Form PF in the future to elicit other information with no relation to systemic risk.”

Part of the enhanced scrutiny on portfolio companies could involve regulators focusing on portfolio investments that have been restructured and checking whether they were properly written off for the purposes of management fee calculation, said Rozenblit.

This came to attention in a December enforcement action the SEC brought against Global Infrastructure Management. Part of the SEC’s three claims against the firm was inconsistency between GIM’s private placement memorandums for its first and second funds, and the contracts for both those pools.

The private placement memorandums stated management fees would be reduced in a partial sale of a portfolio company, while the LPAs for both funds said a partial sale would not reduce management fees, the SEC said.

GIM agreed to pay a $4.5 million penalty to settle the case, and repaid $5.4 million to LPs as part of its efforts to correct the issues, the SEC said. The firm did not admit or deny the charges.