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Davis Polk Discusses Developments in Regulation Related to Private Equity

Rules and regulations

SEC proposes amendments to bolster private fund reporting

On January 26, 2022, the Securities and Exchange Commission (SEC) voted to propose certain amendments to Form PF designed to facilitate the SEC’s oversight of private fund advisers and bolster its investor protection efforts. The proposed amendments are also designed to enhance the Financial Stability Oversight Council’s ability to monitor and assess systemic risks presented by the private fund industry. See our client alert highlighting the key elements of the proposed amendments.

Industry update

SEC statement regarding Form CRS disclosures

On December 17, 2021, the SEC Standards of Conduct Implementation Committee (the Committee) published a statement outlining its observations regarding compliance with Form CRS requirements. SEC-registered broker-dealers and investment advisers (firms) that offer services to retail investors must file with the SEC and provide to retail investors relationship summaries on Form CRS designed to allow retail investors to make informed decisions about whether a brokerage or investment advisory relationship (or a combination of the two) best suits their particular circumstances and investment objectives.

As the Committee has been evaluating whether the relationship summary is fulfilling its intended purpose – “to promote transparency, comparability and better-informed decision-making, through clear, concise disclosures, and by summarizing in one place selected information about a particular firm” – it has shared its observations as to the areas in which compliance improvements are most needed, encouraging firms to review their relationship summaries in light of such observations.

In light of these observations, the Committee encouraged firms to review Form CRS’ specific requirements and contact the SEC with any interpretive questions.

SEC names William A. Birdthistle as Director of the Division of Investment Management

On December 21, 2021, the SEC announced the appointment of William A. Birdthistle as Director of the Division of Investment Management. Currently a professor at Chicago-Kent College of Law, Birdthistle’s research focuses on investment funds, securities regulation and corporate governance. Birdthistle will replace Sarah ten Siethoff, who has served as Acting Director since January 2021.

SEC Division of Examinations’ observations from examinations of private fund advisers

On January 27, 2022, the SEC Division of Examinations (EXAMS) published a Risk Alert highlighting its observations of compliance shortcomings by registered investment advisers that manage private funds (private fund advisers).

This Risk Alert followed up on a prior Risk Alert EXAMS published on June 23, 2020 on the topic and focused on four categories of compliance issues observed among private fund advisers: (1) conduct inconsistent with disclosures; (2) use of misleading performance and marketing disclosures; (3) due diligence failures and (4) use of potentially misleading hedge clauses. EXAMS encouraged private fund advisers to review and enhance their compliance programs in light of these observations.

Conduct inconsistent with disclosures. EXAMS staff observed private fund advisers failing to act in accordance with material disclosures they had made to clients or investors in the following areas:

Failure to follow fund disclosures regarding adviser personnel – EXAMS staff noted private fund advisers’ failure to adhere to the “key person” process outlined in the fund’s LPA.

Disclosures regarding performance and marketing. EXAMS staff observed private fund advisers providing misleading marketing statements to investors and prospective investors in contravention of Rule 206(4)-8 of the Advisers Act. It also noted deficiencies in the maintenance of the underlying materials used to form the basis for, or demonstrate the calculation of, performance or rate of return of managed accounts or securities recommendations.

Due diligence. In violation of Rule 206(4)-7 of the Advisers Act (the Compliance Rule) EXAMS staff observed failures in the due diligence process.

Hedge clauses. In contravention of Sections 206 and 215(a) of the Advisers Act, EXAMS staff observed private fund advisers using hedge clauses in documents to purportedly limit or waive the fiduciary duty imposed by the Advisers Act except in certain circumstances, such as a non-appealable judicial finding of gross negligence, willful misconduct or fraud.


SEC settles with investment adviser for alleged failure to properly offset management fees

On December 20, 2021, the SEC issued an order (Global Order or Order) instituting and settling administrative proceedings against Global Infrastructure Management, LLC (Global), a registered investment adviser with assets under management of approximately $77 billion, for certain alleged failures relating management fee offsets.

According to the Global Order, the private placement memoranda (PPMs) and Limited Partnership Agreements (LPAs) for two Global-managed private equity funds (Fund I and Fund III) stated that Global would offset advisory fees that Global received against fund-level management fees otherwise payable by limited partners. The SEC alleges that due to “deficiencies in [Global]’s compliance program,” such as failing to have written policies and procedures to confirm the accuracy of fee offsets, certain advisory fees received from a portfolio company of Fund I were not properly offset. Similarly, the SEC alleges that certain director fees received on account of a portfolio company of Fund III were not offset.

The Global Order also states that the PPMs and LPAs for Fund I and a second fund, Fund II, did not consistently and accurately describe the calculation of management fees. According to the SEC, the PPMs for Fund I and Fund II each stated that in the event of a partial disposition of investments in a portfolio company, management fees would be charged based on the fund’s remaining interest in the company. The SEC alleges that the LPAs for Fund I and Fund II provided that management fees would be calculated based upon limited partners’ capital contributions used to fund an investment and, accordingly, would not be reduced on account of a partial disposition. These inconsistent disclosures allegedly led Global to provide inconsistent responses to investors’ inquires about offsets; allegedly, Global informed one investor that partial dispositions would reduce management fees and told others investors that partial dispositions would not reduce management fees. Global allegedly did not reduce fees on account of partial dispositions; this was consistent with the LPAs, but not consistent with the disclosures in the PPMs.

Global later reviewed the effects of these alleged failures on its investors, and voluntarily provided a total of approximately $5.4 million, plus interest, in remediation to affected limited partners of the Funds. Global also enhanced disclosures and improved procedures and controls relating to the calculation of fee offsets.

On account of the alleged disclosure and compliance failures, Global allegedly violated Section 206(2) and 206(4) of the Advisers Act, and Rules 206(4)-8 and 206(4)-7 thereunder. In addition to the voluntary remediation described above, Global agreed to be cease and desist from further violations, to be censured, and to pay civil penalty of $4.5 million.

This post comes to us from Davis Polk & Wardwell LLP. It is based on the firm’s memorandum, “Private Equity Regulatory Update – January 2022,” dated January 31, 2022, and available here.

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