The SEC has approved new rules aimed at increased oversight over private equity and hedge funds. In an effort to bolster transparency, the agreed upon Amendments to the Investment Advisors Act of 1940 require private fund advisors to provide quarterly statements with detailed disclosures regarding fund performance and fees. The statements must also reveal investors who were granted preferential treatment regarding redemption rights and other terms. The SEC requires that preferential terms be offered to all investors and prohibits preferential treatment of certain investors to the detriment of other investors. Funds will need to undergo annual audits and obtain a valuation opinion prior to investors selling their interests. While the SEC will allow advisors to charge investors for the costs of government investigations and regulatory and compliance issues, if disclosed, the funds will be tasked with paying for investigations resulting in enforcement actions.
The SEC Chair, Gary Gensler, views the rules as means to hold intermediaries that come between investors and companies accountable, while simultaneously improving competition and efficiency. Approval of the rules was not unanimous, as opponents remained concerned that the SEC was exceeding its authority. There were strong objections from private equity, real estate, venture capital, and hedge funds troubled by this intrusion on private negotiations. Market participants, including the Managed Funds Association, were monitoring the SEC’s actions and determining the next steps to protect the interests of alternative asset managers and their investors. While disclosure requirements will create transparency, it remains to be seen if they will also invite litigation risks.
Recently the SEC expanded the areas of focus that will be subject to its ongoing examination sweeps in compliance with the Marketing Rule under the Investment Advisers Act of 1940. While the SEC has not released any observations nor has there been guidance on the Marketing Rule’s requirements since its initial unveiling, the SEC has expanded the scope of the sweeps with additional “general prohibitions.” These additions indicate the SEC’s intent to issue deficiencies for violations of the broad and undefined “fair and balanced” and “materially misleading” standards.
The SEC states it is reviewing whether advisers are in compliance with the Marketing Rule requirements in regard to the use of testimonials and endorsements in advertisements. The new requirements the SEC will be focused on are: (1) clear and prominent disclosures, (2) oversight conditions being in compliance with the Marketing Rule, (3) proper written agreements with promoters, and (4) whether ineligible persons have been compensated for testimonials or endorsements. While many advisors were hopeful for more guidance following challenging negotiations with placement agents, the SEC’s latest expansion, however, only served as a notice that the SEC will pay close attention in exams and advisers should expect deficiencies
Recently, the SEC proposed new rules (the “Proposal”) for broker-dealers (“broker”) and investment advisers (“adviser”) on the use of predictive data analytics (“PDA”) and PDA-like technologies when interacting with investors. This Proposal comes absent any evidence of abuse by brokers or advisers using PDAs or PDA-like technologies. Yet, the Proposal would require brokers and advisers to evaluate the technology for conflicts of interest and eliminate such conflicts when engaging with an investor.
The Proposal broadly defines “covered technology” to include any “analytical, technological, or computational function” that predicts investment-related outcomes, which includes “PDA-like” technology. Proposal also broadly defined “conflicts of interest” as any use of “covered technology” that considers the interest of the broker, advisor, or any associated person. If adopted, these rules would impose significant operational challenges as well as expensive burdens on the brokers and advisors who use PDA-like technology, especially since “covered technology” could also mean basic technology such a spreadsheet, or commonly used math formulas.
Accordingly, to adhere to SEC regulation, brokers and advisers must disclose such PDA-related conflicts to investors fully and fairly. However, under the proposed rule, if a broker or adviser uses PDAs technologies, they must eliminate conflicts of interest caused by it. This directly contradicts the current SEC regulations which only require full disclosure of the conflict. Thus, eliminating the disclosure requirement will effectively prevent brokers and advisers from communicating with investors using technology that is expressly permitted under different SEC regulations.
While the Proposal appears “to be technology neutral,” dissenting Commissioners highlight that the new rules are likely to impose a substantial burden on the use of any technology in communicating with investors or managing investments.
In last month’s issue of the Executive Liability Insights, we reported that a New York federal judge ruled that a digital token does not constitute a security when it is sold directly to institutions, but it becomes a security when it is offered on exchange platforms as part of an investment contract. A few weeks later, a different federal judge in the same New York district issued a conflicting ruling, stating that tokens sold on marketplaces should be deemed securities that are subject to SEC regulations.
In the new ruling, the judge explicitly rejected the distinction that the judge of the earlier ruling drew between the sales to an institutional purchaser or a retail investor. In doing so, the judge held that advertising the profitability of digital assets to investors qualified such assets as securities.
Although the decisions were made during different procedural stages, these cases are unlikely to become the final guidance on the issue. Therefore, it will remain important to continue monitoring how higher courts resolve the split of judicial rulings on the issue.
Director/Officer |
Role |
Company |
Mina Tadrus |
Founder/CEO |
Tadrus Capital LLC |
Timothy Overturf |
Founder/CEO |
Sisu Capital, LLC |
Ashraf Mufareh |
Co-Founder |
ONPASSIVE LLC |
Director/Officer |
Role |
Company |
Mina Tadrus |
Founder/CEO |
Tadrus Capital LLC |
Timothy Overturf |
Founder/CEO |
Sisu Capital, LLC |
Ashraf Mufareh |
Co-Founder |
ONPASSIVE LLC |
Amount |
Director/Officer |
Role |
Company |
$1,625,000 |
Ulrich Kranz |
CEO |
Canoo Inc. |
$1,769,426 |
Chad Stickforth |
Director |
RSF Capital, LP |
$8,929,120 |
George Iakovou |
Co-Founder |
Vika Ventures LLC |
$24,000,000 |
William Shihara |
Co-Founder/CEO |
Bittrex Inc. |
Amount |
Director/Officer |
Role |
Company |
$ 1,625,000 |
Ulrich Kranz |
CEO |
Canoo Inc. |
$1,769,426 |
Chad Stickforth |
Director |
RSF Captial, LP |
$8,929,120 |
George Iakovou |
Co-Founder |
Vika Ventures LLC |
$24,000,000 |
William Shihara |
Co-Founder/CEO |
Bittrex Inc. |