August 28, 2023

More On: SEC Adopts Private Fund Adviser Rules

John blogged last week about the SEC’s adoption of new rules and amendments intended to tighten the regulation of private fund advisers. Like most recent rules, they were approved by a 3-2 vote along partisan lines. As John stated last year on Blog, “it’s gotten to the point where when you read one of our blogs about rule adoptions you should just assume that was the vote unless we tell you otherwise.” So, while the vote isn’t particularly noteworthy, the dissenting statements from Commissioners Peirce and Uyeda are worth spending a minute on.

While acknowledging that the final rules “are less constricting than those originally proposed,” Commissioner Peirce expressed her perspective that the final rules are “ahistorical, unjustified, unlawful, impractical, confusing, and harmful.” She discussed the related sections of the Investment Advisers Act and Dodd-Frank and argued that they don’t provide a sufficient statutory basis for the rulemaking:

These provisions fall within a subsection titled “Authority to Establish a Fiduciary Duty for Brokers and Dealers,” which is part of a section added to Dodd-Frank to address concerns around standards of care for retail investment advisers and broker-dealers. Relying on a statutory provision that is clearly aimed at retail investors’ relationships with their financial professionals is questionable, to say the least. The release nevertheless strains to use a provision aimed at “sales practices, conflicts of interest, and compensation schemes” to place itself in the middle of negotiations between private fund advisers and investors. While the release acknowledges that section 913 makes numerous references to “retail investors,” it takes comfort in the fact that “Congress spoke of ‘investors,’ and in so doing gave no indication that it was referring to ‘retail customers[]’ . . . .”

There was an indication that it was still focused on retail, even though it was using the term “investor”; that indication came in the fact that the whole section is retail-oriented. The use of the term “investor” instead of “customer” in section 211(h)(2) is not designed to pull in private fund investors, but allows the Commission to regulate interactions between financial professionals and retail investors before they become customers.

Among Commissioner Uyeda’s concerns was the rule’s potential to exacerbate the entrenchment of the largest investment advisory firms:

Finally, many commenters expressed concern that the rules will disproportionately impact smaller advisory firms, which are owned to a greater degree by women and minorities. Smaller firms will have more difficulty undertaking the additional obligations required by these rules. The House Appropriations Committee “strongly encouraged” the Commission “to reconduct the economic analysis for the Private Fund Advisers proposal to ensure the analysis adequately considers the disparate impact on emerging minority and women-owned asset management firms, minority and women-owned businesses, and historically underinvested communities.” It is unfortunate that the Adopting Release dismissively responds to these concerns by stating that investment advisers “have the option of reducing their assets under management to forego registration, thereby avoiding the costs of the final rule that only apply to registered advisers, such as the mandatory audit rule.”

Asking women- and minority-owned advisers to reduce their assets under management to under $100 million to avoid registration is astonishingly terrible advice. In other words, never dream big.

These are some big topics that we can’t help tackle here (even if we’d like to)! But Commissioner Peirce also raised the issue of implementation challenges — citing “uniformity of the disclosures required, the breadth and ambiguity of the rule’s defined terms, the operational difficulties of providing advance notice of any preferential treatment related to material economic terms, the process for obtaining investor consent, the chilling of communications between advisers and investors, and the brevity of the compliance period.” For that, we have resources! We’ve posted the adopting release in our “Private Equity” Practice Area, and we’ve already begun posting memos about the rule there as well!

Meredith Ervine