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Watered Down SEC Fund Disclosure Changes Still Worth Paying Attention To

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On August 23, the SEC passed a handful of new fund disclosure rules concerning clawbacks, preferential treatment of LPs and fees. Fund managers might not have paid much attention to this, though; the rules that the SEC passed were a watered-down version of the initial proposals, including the removal of a potential rule change that VCs seemed most worried about regarding fiduciary duty. But there are still a few things that VCs should pay attention to — especially emerging managers.

The Changes to the Rules

The changes to the rules, while not drastic, have the potential to make fundraising more difficult for VCs. Also, punishment for not following the rules correctly will fall on GPs themselves; they can’t turn to their LPs for financial help anymore. Chris Harvey, an emerging fund lawyer at Harvey Esquire APC, compared the changes to learning a new dance.

"Everyone is doing the waltz," he said, "but now we are getting rid of the waltz, and we are moving to a new style. There will be some toe stepping, and not everyone will be on the beat."

The Treatment of LPs

There are two key rule changes for VCs to consider.

Preferential Treatment

First, there’s new language regarding preferential treatment. The new fund disclosure rules require firms to disclose any preferential treatment of an LP that could have material or negative impact on the other LPs involved in the fund. This could include giving an investor a different capital call structure, different rights to co-investments or different fees.

Firms would have to disclose this preferential treatment to any prospective LPs in addition to an annual written notice to all existing LPs. Harvey said that other LPs having different terms won’t bother some smaller firms, but it could be more of an issue for larger ones.

"If you’re a big firm with lots of LPs," he explained, "it might not be as big of a deal. But if you’re a smaller firm with fewer LPs, it could be more of an issue."

Disclosure Requirements

In addition to disclosing preferential treatment, firms will also have to disclose other information, such as:

  • The identity of each LP and the amount they invested
  • The terms of each investment, including any special rights or preferences
  • Any changes to the firm’s capital structure or ownership

These disclosures will be required annually, and firms will also have to keep records of all communications with their LPs.

The Impact on Emerging Managers

The changes to the rules could have a particularly big impact on emerging managers. If they are caught favoring one LP over another, they may be on the hook for money the firm doesn’t have — for example, if they haven’t started seeing exits or earning distributions yet.

"It’s not just about complying with the rules," said Harvey. "It’s also about being honest and transparent with your LPs."

Compliance Costs

While the changes to the rules may seem daunting, compliance costs are estimated to be relatively low — around $11,000 a year. Firms simply need to make sure they are covering their bases.

"If you’re going to disclose everything," said Harvey, "it should be pretty easy to comply with."

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