Time is ticking for RIAs to adapt to the SEC Rules of Private Fund Advisersthe most demanding of which will enter into force at the end of this year and at the beginning of 2025.
Advisers should start preparing for stricter quarterly reporting requirements for private funds that will take full effect next March, according to compliance consultants.
The SEC issued its package of Private Fund Advisers Rules in August 2023 to improve transparency and eliminate conflicts of interest among fund administrators. of the number of private funds in the US market has has increased recently. By mid-2023, there were 47,443 such funds, with 3,798 advisers advising them, an increase of nearly 27% from the first quarter of 2021, according to the SEC. US-based individual investors were the beneficial owners of 9.6% of the total NAV of these funds. When announcing the Private Fund Advisers Rule, SEC Chairman Gary Gensler noted that the package was being advanced “on behalf of all investors—large or small, institutional or retail, sophisticated or not.”
Looking at quarterly reports, for example, shows LPs exactly how much they're paying for their funds' performance, “and it's probably more than they thought,” said Igor Rozenblit, managing partner of Iron Road Partners, a compliance consultancy with based in New York. strong.
Getting approval from their compliance department is already one of the top challenges facing RIAs investing in illiquid alternatives, second only to lack of liquidity, according to a recent survey by market research firm Fuse Research Network. Thirty-eight percent of respondents, including 30% of RIAs and 40% of independent brokers, listed it as a challenge.
Additionally, a survey of alternative fund managers administered earlier this year by global fiduciary services firm Ocorian in partnership with Newgate Compliance found that 88% of respondents expected their compliance risk to increase over the next two years. next. The survey included over 100 executives overseeing regulation and compliance at alternative fund management firms around the world and focused primarily on fund managers' work with institutional clients.
“Unless an RIA is working through a platform that controls the alts manager and will verify/monitor that the investment manager has the systems and operations and vendors in place to implement and follow their investment management process as promised… I don't I'm sure you can get comfortable with firms outside of the more established brands,” Neil Bathon, managing partner of Fuse Research Network, wrote in an email.
Standards will change
The Private Fund Advisors regulation package is currently being challenged in court by a coalition that includes the National Association of Fund Managers, the American Investment Council and the Managed Funds Association, among others. The plaintiffs argue that the SEC is overstepping its authority to oversee private funds. A panel of judges from the 5th Circuit Court of Appeals heard oral arguments on the case in February. Observers expect a decision next month, and it is not certain that the SEC will win the case, according to Rosenblit.
However, the largest private fund managers are already indicating that they will adopt stricter reporting standards in some capacities, regardless of whether the SEC requires it. This means that smaller VNRs that directly or indirectly advise private funds may have to follow suit to stay competitive.
In February, the Association of Institutional Limited Partners, a trade group representing institutional limited partners in private equity, launched a project to improve existing reporting models. ILPA asked GPs, service providers and members of industry associations to join its working groups to help finalize a set of new standards by July this year. The organization planned to begin a public comment period in May.
“The SEC's Private Fund Advisers Rule provides a significant opportunity for the industry to work together toward solutions that will satisfy the needs of both LPs and regulators for greater consistency and transparency,” ILPA said in a release. for press.
“There is this case before the 5th Circuit, but in a way, the genie is out of the bottle,” according to Rosenblit. “Many of our clients who are larger and don't come from the RIA side are telling us that because of the attention the SEC brought these issues, regardless of what happens in the 5th Circuit, they voluntarily will respect parts of the quarterly reporting rule.”
And the rule is “just one bear,” Rozenblit noted.
“It may not sound like a significant undertaking, but it is,” said Mike Kell, senior vice president of strategy and education programs at alternative investment platform iCapital. “This is something that is a big change in the industry. I think it's a great thing for end investors, but from an asset manager's perspective and for fund advisors, it's something that a lot of them aren't used to. Even if they are doing some form of reporting, it's probably not at this level or subject to these very specific requirements.”
What to prepare for
Part of the challenge that the VNRs will face is the summary schedule for completing the quarterly reports. The reports will have to be presented to investors 45 days after the end of the quarter, except for the fourth quarter report, which must be issued within 90 days after the end of the fiscal year. The fund of funds will have to submit their reports within 75 days of the end of the quarter and 120 days after the end of the fiscal year.
For each of these reporting periods, the affected RIAs will have to provide information on all fees and expenses charged to the fund, including the methodology for how they are calculated, a table of portfolio investments that will describe all compensation paid to advisers by the fund or allocated to them from covered portfolio investments; and fund performance data. Liquid funds must describe the cumulative total net return for the current fiscal year through the reported quarter and historical net returns for the previous 10 years. Illiquid funds will need to provide gross and net inception IRR, gross and net MOIC and an accounting of contributions and distributions, among other things.
Any expenses charged to the fund would have to be itemized and fit into a predetermined expense category, with no allowance for “miscellaneous” items, according to Rozenblit. He said it will be much more difficult to report the unexpected expenses that tend to arise during the life of the fund.
“You have to have line items for each type of individual expense,” he said. “Each line item should be linked to your limited partnership agreement. And each line item should also be linked to a specific distribution policy or methodology. That means if you don't have one of those, you probably need one of those.”
Getting all this in order and ready to report by March 2025 will be much easier for large alternative asset managers who have been operating private funds for years and have mature compliance departments, he noted. Valerie Ruppel, head of US regulatory consulting with Ocorian.
On the other hand, for retail wealth managers who only recently started offering their own funds, “you have a lot of disclosure obligations that you're going to have to consider,” she said. “It's not that you can't do it, I'd just say be very aware that there's a lot of compliance heavy lifting that goes on behind the scenes to make that program fit for purpose.”
Ruppel recommends that smaller RIA shops keep an eye on how large alternative asset managers handle upcoming changes to quarterly reporting rules. For this purpose, future changes to the template being worked on by ILPA may be considered. Advisers may also consider hiring a compliance consultant to help them navigate the process. Another option for smaller firms that may not be able to handle extended compliance duties in-house is to partner with online alternative investment platforms such as iCapital, CAIS and others, which typically help RIAs to handle compliance issues through a simple process, according to Mike. Kell.
However, one of the first things everyone should do is build a template for quarterly reports, according to Rozenblit. To do this, firms should review their existing fee structures, performance data sets, leverage and other relevant information.
“Our customers are making their own templates; they are tying them to their partnership agreements and their distribution methodologies. They are configuring their systems so that data can be extracted easily. And they're testing them and making sure they're doing it right,” Rozenblit noted.
While preparing to present investors with quarterly reports is a massive undertaking, it could ultimately lead to private funds becoming much more attractive to retail investors, he noted. Historically, the argument against retail investors putting money into private vehicles was that they were too easily regulated. If regular reporting becomes standard industry practice, “that argument becomes less effective. This enactment could be one of the things that could open up the world of private equity and hedge funds to retail.