Friday Letter: 3 things you need to do following the SEC’s bombshell proposal

If you have not read all 341 pages of the SEC’s proposed new rules for private funds, don’t worry. Reading all those pages will only leave you with more questions than answers.

Here are three things you need to do, per Kelly DePonte, managing director of placement advisory service Probitas Partners, which has helped more than 116 private fund managers raise more than $100 billion for VC, private equity and other funds.

One, call your fund-formation attorney, especially if you are in market with a fund and haven’t held a first close. Your attorney will be able to flag potential problems that might arise from any new regs.

Two, if you’re among the growing number of firms that outsource their back office, call your service provider. You want to find out if they will be able to handle any increased work that comes from new regs and – most importantly – what the expanded service is going to cost.

Three, after you’ve spoken to your attorney and service provider, make sure you file comments with the SEC to hopefully convince the regulator to rethink or scrap its proposed rules. The comment deadline is April 11, or 60 days from the SEC notice posting in the Federal Register, whichever is sooner.

“If you’re a VC and you’re worried, you’d better get a response into the SEC now,” DePonte said. “The SEC will listen not just to well-written arguments but to a lot of people saying, ‘you shouldn’t do this.’”

Here is how to get in touch with the SEC:

• To submit a comment using the SEC’s online form, go to http://www.sec.gov/rules/submitcomments.htm
• For email, send your comments to rule-comments@sec.gov and include “File Number S7-03-22” in the subject line.
• For paper comments, address them to Vanessa A Countryman, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090.

To get up to speed on the SEC’s proposed rule changes, read our prior coverage here.

If the SEC rules are adopted as is, they would create major headaches for GPs. For example, the commission has proposed a ban on preferential treatment of certain investors in a fund, regardless of whether that fund is registered or unregistered, as is the case with most VC firms.

The SEC proposal states: “In order to address specific types of preferential treatment that have a material negative effect on other investors in the private fund or in a substantially similar pool of assets, we also propose to prohibit all private fund advisers, regardless of whether they are registered with the Commission, from providing preferential terms to certain investors regarding redemption or information about portfolio holdings or exposures.”

Gimme a break

Offering certain LPs a special deal is quite common. For example, to encourage an LP to be an anchor investor, a GP might offer an economic break.

While the SEC is suggesting an outright ban on preferential treatment, it is willing to hear arguments against the move. It includes no fewer than 27 questions in the filing, such as: should the proposed rule apply only to SEC-registered advisers, should it apply “only to terms that the adviser reasonably expects to have a material, negative effect” and should the SEC require advisers to provide advance written notice to prospective investors?

You can imagine all sorts of scenarios where this issue would come up. If you’re raising a first-time $100 million fund and want to give a break to an LP who writes a $50 million check, could you avoid getting dinged for preferential treatment if you offer the same deal to all LPs from the outset?

It isn’t clear what the answer is. “It’s almost like shooting in the dark because what they have [written] down is so broad,” DePonte said. That’s why you need to talk to an expert. “If you haven’t had a first close [on a fund], you’ve got to have a conversation with your fund-formation attorney,” DePonte added. “If something is going to be a big issue, they may suggest you deal with it now.”

If you are not fundraising any time soon, you have time to work through the potential challenges. The SEC will need to consider all the feedback it gets once the comment period is complete. It could then issue a revised version of the proposed rules or it could issue a completely new proposal and solicit comments on that. The latter scenario is more likely, according to Amy Lynch, a former SEC examiner and founder and president of FrontLine Compliance, whose clients include venture capital firms. She expects heavy industry pushback on the proposals.

“I do not see a final rule coming out on this particular proposal until next year,” Lynch said. “My caveat is that we are dealing with a very aggressive SEC.” Chairman Gary Gensler “may very well want to take advantage of [his 3-1 voting edge on the commission] and push something through because he has the votes.”