Navigating SEC Scrutiny: How Private Equity Firms Can Stay Ahead of Regulatory Changes

Private equity has been long considered a "lightly regulated industry" until recently when the government decided to change its approach and increase transparency, fairness and accountability" in the sector. The recent rulemaking initiatives by the U.S. Securities and Exchange Commission directed towards private funds and investment advisors set a clear trend for new regulatory requirements. Below, we discuss key SEC initiatives, the novel challenges for the sector and how private equity firms can get a better footing at compliance by implementing new processes and leveraging regulatory filing software.

SEC Rulemaking for Private Equity 

Over the last few years, the SEC has initiated a number of rules with a direct impact on the private equity sector. While one of them was already overturned by court, with several others still in the making, it is already evident that the SEC will keep PE firms on its radar.

Rules for Private Fund Advisers

Under a new set of rules initiated in August 2023, the SEC required private funds to:

•  issue expanded quarterly financial statements,
• disclose any preferential treatment of investors via so-called 'side-letters,'
• conduct annual audits,
• get a 'fairness opinion' on secondary transactions led by advisers,
• restrict certain activities without submitting complex disclosures.

The regulator voted 3:2 to implement the Rule with the goal of increasing transparency, fairness and accountability in the industry, known to account for $25 trillion in assets. To the relief of many, in June 2024, the Fifth Circuit Court of Appeal struck down the new Rule, finding that the SEC overstepped its authority. Still, it is anticipated that the regulator will keep its focus on private entity firms and leverage its statutory tools to challenge policies, processes and disclosures related to transactions and preferential terms considered as "restricted" according to the Rule. 

Safeguarding Advisory Client Assets

The Safeguarding Advisory Client Assets Rule expands the scope of assets covered under the existing custody rule of the Investment Advisers Act of 1940, extending beyond clients' funds and securities. Under the new proposal, the Rule will encompass all assets held in advisory accounts, including crypto, cash, art and other physical assets. 

Predictive Data Analytics Rule

Seeking to eliminate conflicts of interest, the SEC has initiated yet another set of rules related to the use of predictive data analytics in investor interactions by investment advisers and broker-dealers. The proposed Rule requires a firm that uses predictive data analytics technology in an investor interaction to have written policies and procedures designed to prevent violations or achieve compliance. 

Outsourcing Rule 

Under the new Rule proposed back in 2022, the SEC initiated new standards for registered investment advisers that outsource some of their "core advisory functions." According to the SEC Outsourcing Rule, a registered investment advisor is required to conduct due diligence and monitor service providers continuously and keep records of such due diligence and monitoring.

Cybersecurity Rule

In its newly proposed cybersecurity risk management regulation, the SEC expects registered advisers and funds to implement policies and procedures to address cybersecurity risks, report significant cybersecurity incidents and file risks and incidents disclosures.

Challenges for PE Firms Presented by SEC Regulatory Initiatives

Whether the SEC decides to appeal the decision of the Fifth Circuit Court or has any of its other proposals enacted, it can be reasonably anticipated that the regulator will continue to focus on the "policies, processes and disclosures" of PE firms related to the subject of respective regulations. 

The current state of regulatory uncertainty increases the risks faced by businesses managing investor funds and capital acquisitions. An unclear scope of responsibilities raises the bar of requirements for data readiness as firms need to be well-equipped for extensive data extraction and reporting to ensure new criteria for transparency. 

How Can PE Firms Stay Ahead of SEC Rulemaking?

Due to the detailed nature of SEC rules, businesses will need to revisit their reporting approaches and introduce new processes and technology to achieve compliance. The new rules for disclosure impose additional workload and workforce requirements, which can get out of control in the absence of effective technology, such as regulatory filing software and advanced entity management system.

Private entity firms seeking to stay ahead of SEC rulemaking need to be well-prepared for increased scrutiny. In particular, businesses would be much better positioned in the changing regulatory landscape as they:

• build awareness of forthcoming changes by fostering industry relationships,
• continuously assess the impact of new SEC proposals,
• ensure accurate record keeping,
• stay audit-ready at all times,
• initiate processes required to quickly produce summaries of any preferential treatment,
• have clear policies on using data analytics technology to avoid conflicts of interest,
• run due diligence and monitor their service providers that fulfill any of the core advisory functions,
• have clear procedures for managing cybersecurity risks.
  

Ensure Compliance with Regulatory Filing Software

The SEC scrutiny toward private entity firms requires new approaches and technologies aimed at ensuring compliance and providing timely reporting. Companies leveraging outdated systems or spreadsheets are ill-prepared to handle the unprecedented level of detail expected by SEC proposals. 

The Athennian team is tracking the development of SEC rules and regulations to share how they can affect our clients and provides effective regulatory filing software to ensure compliance. For more information, please do not hesitate to contact the Athennian team to request a free demo.