SEC seeks rule change that could cause fund managers to take less risk

The sweeping changes the SEC seeks would make fund managers more accountable than current standards if they don’t impose a higher standard of care.

The rule changes include lowering the compensation standard for fund managers from “gross negligence” to “ordinary negligence”. The latter, the current standard, allows limited partners to sue general partners solely for recklessness or disregard for obvious risks. But if it were changed to “common negligence”, the limited partners might be able to sue for simpler errors, making it easier to bring a claim against the GP.

“This will dramatically change the relationship between fund managers and investors,” Marc Elovitz, partner and chairman of the regulatory practice at Schulte Roth & Zabel, told the Delivering Alpha Newsletter.

Schulte’s Elowitz, whose law firm represents investment funds, said: “A fund manager’s ability to take risks and be protected by their simple, day-to-day actions is critical to developing investment strategies that are likely to yield higher returns. “If you want to own funds that offer potentially higher returns, there are risks associated with that. It will be very difficult for investment managers to protect themselves from those risks.”

Even the Institutional Limited Partners Association, which has been broadly supportive of the rule change, has raised concerns about the adverse effects of a broad change to the standard.

“ILPA believes that general application of the common negligence standard will have unintended consequences, impacting (general partners’) risk tolerance and potentially undermining the returns generated by private equity funds,” the group said in a statement. recent analysis the content of the proposal.

However, the ILPA said, “a common negligence standard applicable to breaches would ensure meaningful progress.”

SEC Chairman Gary Gensler explain In the past, the proposal prohibited private equity fund advisers from “engaging in a number of activities contrary to the public interest and investor protection,” including indemnifying or limiting their liability for certain activities. The SEC did not respond to our request for comment on this release.

Originally proposed in February 2022, the Private Fund Advisor (PFA) rules cover a wide range of topics, including quarterly fee and expense reporting and preferential treatment of certain limited partners over others. Compensation changes are part of the reform. In a recent memo to clients, several law firms said they expected a final vote on the rule this year.

Critics said that if passed in its current form, the reform would certainly affect the risk tolerance of private equity funds, which would need to be more cautious when making investment decisions.

It’s a bit like taking your kids to an amusement park, but only on a carousel instead of a roller coaster. For many, it may not be worth the price of admission.