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On 9 February 2022, the Securities and Exchange Commission (“SEC”) released its proposed Private Fund Advisers rule, with the primary goal of promoting transparency for private fund investors by requiring registered investment advisers to disclose the full cost of investing in private funds, as well as the performance of such funds. Following the commentary period, the Institutional Limited Partners Association (“ILPA”) submitted its recommendations which included developing an approach to allocating costs to partnerships, implementing measures to prevent unintended consequences, and implementing a “best-in-class” Most Favoured Nation (“MFN”) process.
ILPA recommendations
- Allocation of costs to the partnership
Limited Partners (“LPs”) have sought further transparency into fees and expenses due to increases in the total fees they are paying, particularly those that fall outside the management fee. The ILPA believes that some costs are not appropriate to allocate as a partnership expense. These expenses include overhead costs like office space, furniture, computers, telephones, facilities, utilities, and communications, as well as remediation and settlement costs stemming from examinations, investigations, or enforcement actions.
- An approach to avoiding unintended consequences
The ILPA suggests that the SEC should refrain from prohibiting emerging managers from charging LPs for General Partners’ (“GPs”) use of third-party administrators for quarterly reporting and statements. Furthermore, the SEC should grant an exemption to emerging managers to levy partnership costs of filing form Private Fund and form ADV with the SEC. Additionally, an exception should be made to the prohibition of allowing co-investments to impose certain non-pro-rata fees to the fund. Lastly, a best-in-class side letter approach should be established that creates minimum standards for LPs and provides them with necessary transparency into side letters.
- Implementation of a “best-in-class” MFN process
To promote transparency and ease of understanding, the ILPA has suggested several guidelines for the presentation of the MFN. Firstly, all LPs in the fund should be granted access to the MFN and provided with insight into all the terms, regardless of their level of commitment or ability to elect specific terms. GPs should avoid using redactions wherever possible, except in circumstances where personal/private information is disclosed. Secondly, GPs should aim to make the MFN comprehensible and transparent. The MFN should not be limited to side letter requests but should encompass all pertinent terms agreed upon between GP and LPs that impact the fund, including those in representation letters, due diligence letters, or any other separate agreement. The MFN process should not permit individual LPs to opt out and exclude their terms from the compendium. Finally, the ILPA recommends that GPs aim for the best treatment of costs associated with the MFN process as an organisation expense, as opposed to a fund or partnership expense.
next steps
The proposed changes will have a significant impact on the structuring, negotiation, and approval of agreements between LPs and GPs within the private equity industry. Private fund advisers and investors will need to consider how the proposed rules will affect their relationships. We can utilise the proposed changes to effectively negotiate the Limited Partnership Agreement and other investment documents in your favour.
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