Private fund industry prepares for battle over sweeping US rules

Receive free US financial regulation updates

We’ll send you a myFT Daily Digest email rounding up the latest US financial regulation news every morning.

The global private funds industry is bracing for one of the most sweeping regulatory reforms in its history as the US Securities and Exchange Commission prepares to impose tough rules on private equity, real estate and hedge funds.

The far-reaching rules, first proposed in February 2022, are aimed at protecting investors by requiring detailed quarterly reporting on performance, prohibiting secret side deals that give better terms to some investors and limiting what expenses private managers can pass on to their clients.

If the SEC adopts them unchanged at its open meeting on Wednesday, they would capture not just tens of thousands of US private funds but also overseas managers who take money from American investors.

The changes would be the most significant overhaul since at least the 2010 Dodd-Frank financial reform law for an industry with $25tn in assets, and “potentially ever”, said Christine Lombardo, an attorney at Morgan Lewis.

“For the first time, really, the SEC, especially in the institutional space, [would be] effectively dictating what terms you can and can’t give in the context of institutional arrangements between private fund managers and their investors,” she said.

Industry groups warn that because the rules do not exempt existing arrangements, tens of thousands of contracts with investors, some of them decades old, will have to be torn up and renegotiated within the next 12 months. Several are threatening to file a lawsuit, arguing that the SEC is improperly trying to control investment terms by limiting what funds and clients can agree to.

“If the rules come out as proposed, we feel the SEC would be exceeding its statutory authority,” said Jack Inglis, chief executive of the London-based Alternative Investment Management Association. “It really upends the whole concept of freedom of contract between buyer and seller.”

Jennifer Han, chief counsel of the US-based Managed Funds Association, said: “They have failed to identify a market failure and they haven’t done a proper cost-benefit analysis.”

The SEC declined to comment, but chair Gary Gensler defended the reach of the proposal earlier this year, saying: “Congress said we had a role to consider efficiency and competition in the capital markets . . . They didn’t leave out so-called sophisticated investors.”

Consumer groups have said the proposals improve accountability and transparency in a rapidly growing sector that receives trillions of dollars in public pension money and is increasingly seeking money from very wealthy individuals.

They particularly praised the SEC for requiring increased disclosure and proposing to ban side agreements that give some investors more favourable terms on crucial issues such as redemption limits.

“This industry is full of conflicts of interest and shady side agreements . . . The private fund advisers are making a killing in the shadows,” said Dennis Kelleher, chief executive of Better Markets, a financial reform group.

Fund managers are particularly exercised by a rule that makes managers financially liable for “negligence” rather than a harder-to-meet standard of “gross negligence”. They said it would curtail innovation and returns by making managers more reluctant to try novel strategies.

The overseas fund industry could be hit as well. Two-thirds of new private market investment came from North America last year, according to a McKinsey study.

“Many London-based fund managers who have US investors are going to be subject to these rigid US rules,” said Marc Elovitz, partner at Schulte Roth & Zabel. “It could cut US investors off from a lot of these funds.”