According to Mr. Holston, the final rule includes a “much smaller menu” of prohibited activities than the original proposal, as some were dropped altogether. One dropped provision would have prohibited fund advisers from seeking reimbursement, indemnification, exculpation, or limitation of liability by a private fund or its investors for certain activities, such as breach of fiduciary duty.
“After considering comments, we are not adopting this prohibition, in part, because we believe that it is not needed to address this problematic practice,” the SEC said in its final rule. “Rather, we are reaffirming and clarifying our views on how an adviser’s fiduciary duty applies to its private fund clients and how the antifraud provisions apply to the adviser’s dealings with clients and fund investors.”
The rule also “reframed” most prohibited practices as restricted, said Aaron Schlaphoff, meaning they are permitted but subject to disclosure and investor consent requirements. Mr. Schlaphoff is a New York-based partner in the corporate department and private funds group at law firm Paul, Weiss, Rifkind, Wharton & Garrison.
Notably, the final rule also includes the addition of what SEC Chairman Gary Gensler called a legacy provision for the restriction of certain activities and preferential treatment. This means advisers will “not need to renegotiate or, one might call, repaper limited partnership agreements” that were made before the rule takes effect, Mr. Gensler said during the Aug. 23 meeting.
The original proposal faced strong opposition from finance industry players, with the primary criticism being “these are negotiated transactions between accredited and institutional investors, and thus, they are able to protect themselves,” said Sean McKee, KPMG’s national practice leader for public investment management, who’s based in New York.
“In general, the institutional investment world, particularly the more liquid hedge fund universe, has done a decent job of regulating itself and has the ability to perform detailed due diligence on managers including all aspects of terms such as liquidity, fees, preferential treatment, etc.,” said James Neumann, Boston-based CIO of London-based Sussex Partners U.K. Ltd, a consulting firm with a focus on hedge funds and other alternative investment strategies, in a written comment. “Holding these sophisticated managers to a higher standard than retail-facing mutual funds therefore seems overly bureaucratic.”
Even Republicans on Capitol Hill have weighed in on the topic.
In an Aug. 23 news release, Reps. Bill Huizenga, R-Mich., and Steve Womack, R-Ark., criticized the final rule, following a July letter that the representatives sent to the SEC asking the agency to reconduct the economic analysis on the rule. The lawmakers chair the House Financial Services Subcommittee on Oversight and Investigations and the House Appropriations Subcommittee on Financial Services and General Government, respectively.
“While it is questionable at best that the SEC has the statutory authority to finalize this rule, the lack of transparency is even more concerning,” the lawmakers said in the news release. “We will continue to look for ways to hold Chair Gensler accountable as he pursues another bureaucratic mandate that lacks congressional approval.”
House Financial Services Committee Chairman Patrick McHenry, R-N.C., called on the SEC to rescind the new rule in his own Aug. 23 news release, adding, “Once again, Chair Gensler’s SEC is exceeding its statutory authority to impose onerous and costly mandates — this time on private funds.”