Private equity firms are likely to face higher compliance costs and a potentially uncomfortable level of scrutiny from federal financial regulators if the U.S. Securities and Exchange Commission follows through on proposed updates to a confidential reporting document, said Dave Brown, a partner at international law firm Alston & Bird LLP who specializes in federal securities laws.
"I think the SEC is underestimating the impact in their economic analysis, as I think they sort of historically do," Brown said, characterizing the financial impact on private equity funds as "significant."
With the proposed amendments to the reporting form known as Form PF, the SEC aims to sharpen a decade-old tool it uses to uncover signs of distress in veiled private fund markets.
Updates to Form PF would require much faster reporting of adverse events from a wider range of private equity funds. Regulators would use that more "granular and timely information" to monitor events that could signal problems for the funds' investors or the wider economy, including pending litigation or an earlier-than-expected fund liquidation, according to an SEC report.
The SEC believes the changes are necessary to keep up with an industry that has grown and evolved significantly since Form PF was first put to use in 2012, according to a statement issued Jan. 26, the start of a 30-day public comment period on the proposed updates. The proliferation of funds since then means just 67% meet the reporting threshold for a Form PF, down from 75% when it was introduced, a trend the proposed changes aim to reverse.
"We have identified significant information gaps and situations where we would benefit from additional information," SEC Chairman Gary Gensler wrote in the statement.
The Institutional Limited Partners Association is still reviewing the proposed amendments to Form PF, said Christopher Hayes, senior policy counsel for the organization representing institutional investors in private equity funds, but it has in the past described the disclosure as an "essential" tool for maintaining a healthy marketplace.
While private equity fund managers now have 120 days to file Form PF following the end of a fiscal year, the proposed changes would require the report to be filed within just one day of a variety of events, including adviser-led secondary transactions, clawbacks and fund terminations. The updated form would also require more information on the investment strategies employed by the managers of large private equity funds, including the use of leverage.
The SEC is expected to face some industry resistance to the changes, which some see as a heavy-handed approach to monitoring risks to the financial system. Others, including Blackstone Inc. President and COO Jonathan Gray, appear ready to take tighter regulations in stride.
Blackstone will simply adapt and comply with any new rules, Gray said on the firm's fourth-quarter earnings call. "[W]e understand that we're in an environment of heightened scrutiny, and we will obviously respond to it in the right way."
Still, Brown argued the reporting changes could be enough to shift some private equity investment strategies, partly due to higher compliance costs narrowing margins. Additional disclosures around investment strategies could also give the SEC a toehold to conduct a deeper probe into a fund’s practices, he added.
"Any time there's a chance for additional examinations, then you have additional investigations and then SEC enforcement. That drives up the cost for companies to comply with these regulations," he said.
Higher expenses for running a private equity fund impacts investor returns, in contradiction to regulatory purpose, Brown said. "One of the things you're trying to do with the protection of investors is help them have capital formation and help them have consistent returns."