Dec. 01, 2022

SEC Proposes New Diligence, Monitoring and Recordkeeping Standards for Overseeing Service Providers (Part One of Two)

On October 26, 2022, the SEC proposed new rules under the Investment Advisers Act of 1940 (Advisers Act) (Proposal) to prohibit investment advisers from outsourcing certain services and functions unless they take steps to reduce the risk of disruptions and failures that could harm investors. The Proposal would require advisers to conduct due diligence before engaging a service provider to perform “covered functions” and to periodically monitor that performance. In furtherance of those goals, the Proposal includes amendments to Form ADV to collect census-type information about service providers, as well as related amendments to the books and records rule under the Advisers Act. In light of the Proposal being published in the Federal Register on November 16, 2022, the comment period will end on December 27, 2022. This first article in a two-part series outlines how key defined terms dictate the scope of the Proposal; the diligence, monitoring and recordkeeping requirements imposed on fund managers; and the anticipated compliance period. The second article will describe the response of SEC commissioners and the private funds industry to the Proposal, including concerns about its purpose, overbreadth and unintended consequences. For coverage of the SEC’s recently proposed private fund rules, see our three-part series: “Overview of the Proposal and the Importance of Industry Comments” (May 24, 2022); “General Observations” (May 31, 2022); and “Rule-Specific Concerns and Next Steps” (Jun. 7, 2022).

How Lawyers Can Leverage the Shifting Environment to Enhance Compliance Programs

In-house lawyers across industries commonly refer to the revenue-generating units of their organizations as “the business,” while legal and compliance departments are referred to as “cost centers” with a pejorative undertone. Notably, the lawyers that operate in those units are keenly aware of the power dynamics that nomenclature reinforces. Shifting perceptions of corporations’ responsibility, however, might give compliance lawyers an opportunity to add value, influence their organizations’ cultures and reframe goals. In a guest article, WTAII PLLC attorneys Warren Allen II and Ray McKenzie share observations and strategies for leveraging those shifts when building and bolstering organizations’ compliance programs. See “Can Compliance Certifications Empower CCOs?” (Oct. 18, 2022).

Marketing Rule Risk Alert Indicates That SEC Guidance Will Occur Via Imminent Examinations

There was a flurry of activity leading up to the November 4, 2022, compliance date for the SEC’s new marketing rule (Marketing Rule or Rule) – Rule 206(4)‑1 under the Investment Advisers Act of 1940 – as fund managers frantically attempted to become compliant with the requirements. Although complying with new SEC rules is difficult in the best of times, the task was even more daunting with the Marketing Rule due to the SEC’s unwillingness to issue an FAQ leading up to the compliance date. Instead, the SEC’s Division of Examinations indicated that guidance will take the form of enforcement efforts via its recent issuance of a risk alert (Risk Alert) highlighting its plans for examining advisers’ compliance with the new Rule. Examinations will focus on policies and procedures; substantiation of claims; books and records; and performance advertising. This article discusses the key takeaways from the Risk Alert – as well as a related investor bulletin on performance claims – with insights from Genna N. Garver, partner at Troutman Pepper, and Krista Zipfel, director at ACA Group. See “A Checklist for Advisers to Guide Compliance With the Marketing Rule” (Oct. 25, 2022); and “A Checklist for Fund Managers to Ensure Their Advertising Materials Comply With the New Marketing Rule” (May 10, 2022).

Enhanced Warnings and Other Obligations From the FCA’s New U.K. Rules on Marketing High‑Risk Investments (Part One of Two)

As part of its consumer investment strategy, the U.K.’s Financial Conduct Authority has introduced a new “consumer duty” (Consumer Duty) that aims to improve how firms serve consumers. In addition, the FCA has finalized new rules for marketing high-risk investments (High-Risk Marketing Rules) to ensure that only investors with appropriate risk appetites invest in high-risk products. Although the Consumer Duty does not go into effect until July 2023, firms must comply with the High-Risk Marketing Rules beginning on December 1, 2022. In light of the broad application of the rules to fund managers, placement agents and other service providers, MJ Hudson partner Mike Booth presented a program examining key features and terms of both rules. This first article in a two-part series provides useful background information for both rules before delving into the nuances and requirements of the High-Risk Marketing Rules. The second article describes relevant takeaways for fund managers about their obligations under the Consumer Duty. For further analysis from MJ Hudson, see our two-part series: “Report Details Increased LP Power in Key PE Terms Marking Alignment of Interests” (Sep. 28, 2021); and “Report Analyzes Trends in Negotiated Terms Relating to PE Fund Governance” (Oct. 5, 2021).

Hybrid M&A Single‑Asset Transactions: Complications to Consider and Negotiating Points to Navigate (Part Two of Two)

Hybrid M&A single-asset deals are the latest iteration of GP‑led transactions to gain popularity in the market, in part because of how the valuation from the M&A deal with the third-party sponsor can be used in the parallel continuation fund transaction. To realize those meaningful benefits, however, sponsors need to prepare to navigate some of the complications arising from a process that involves several transactions with different timelines and mechanics that flow through to certain key deal terms. Those and other facets of hybrid M&A single-asset transactions were discussed by Kirkland partner Eric N. Fischer and his colleagues at the recent Kirkland Liquidity Solutions Academy. This second article in a two-part series summarizes factors that sponsors need to manage throughout the hybrid M&A deal process, as well as potential sticking points that can crop up along the way. The first article highlighted underlying secondary market trends; high-level features of hybrid M&A transactions; notable potential structural variations; and unique advantages the deals can offer. For more from Kirkland partners, see “Emerging Trends in the Evolving Continuation Fund Market” (Jul. 12, 2022); and “A Comparison Between Two Liquidity Solution Tools: Preferred Equity and NAV Facilities” (Oct. 13, 2020).

Reed Smith Adds Two Partners to Its Global Corporate Practice

Edward H. Klees and Brian Farmer have joined Reed Smith’s global corporate group in Reed Smith’s Washington, D.C., and Richmond offices, respectively. Klees’ practice focuses on representing institutional investors with broad spectrum investment management needs, while Farmer’s practice includes representing both open- and closed-end fund managers. For insights from Klees and Farmer, see “Practical Insights on Five Problematic GP/LP Dynamics Identified by SEC Chair Gensler” (Feb. 1, 2022); and “Can a Fund Manager Use a Force Majeure Provision to Extend a Fund’s Investment Period During the Coronavirus Pandemic?” (Jul. 21, 2020).