The SEC’s new marketing rule, which comes into implementation on November 4, represents a complete rewrite, said a panelist at PEI’s Private Fund Compliance Forum. Compliance teams are rushing to rewrite their policies and procedures, while tackling ambiguities in the rule they are unsure they’ll get answers to.
And on top of that, they often need to instigate and manage a change in firm culture.
The overhaul removes the prohibition on testimonials, bans the use of hypothetical performance except in limited circumstances, standardizes the calculation and presentation of performance, and more.
But it also withdraws many of the no-action letters firms have historically relied on, causing firms to update their own policies and procedures to comply with the new rule.
“There are going to be various practices in which the industry has been engaged in for very long time that may no longer be [acceptable] or will have to be done differently following the adoption of the new rule,” one speaker said.
A delegate at another session illustrated a similar point, saying, “Change management is a huge part of fundraising” in the context of the new rule.
“For example, every year we have a global fund that we’ll market,” the delegate, a CCO at a private equity firm, said. “And there are partners who love speaking about [our global fund] and have a certain way they love to advertise or speak with prospects about the fund. And it can be challenging to say that this framework that you know and love, and these terms you’ve always used… we have to change them now.”
“There’s going to be pushback on that,” she added.
The SEC has not yet given any indication that it will issue additional guidance on the marketing rule, and it comes into effect right in the middle of the fundraising cycle for some. “How the heck do you manage that?” the private equity CCO said.
Firms aren’t just scrutinizing marketing materials that are used regularly to ensure they comply with the requirements of the new rule. They are also drilling down on materials which may have been created for a specific investor or for a single usage to be sure they wouldn’t trip up compliance if the materials were used again.
One private fund general counsel said firms are going to have to “liberalize” some policies, such as past specific recommendations and testimonials, which are less restricted under the new rule. But policies regarding hypothetical performance, for example, will have to be amended to be much more conservative.
Among specific aspects of the new rule that are giving compliance officers headaches now is the flat prohibition on reporting gross performance without also including net performance.
The general counsel of a private equity firm said he is hoping for additional guidance coming from the SEC staff on any particular methodology they would propose for the calculation of gross performance before setting a final policy on reporting gross and net performance.
He said managers are considering using performance calculations that are often prepared on a bespoke basis for one or two investors, but these portfolio performance calculations are often labor-intensive, and so don’t represent a favorable solution.
Fund managers can use a model advisory fee presentation of net performance in marketing materials, so long as the performance presented does not end up being better than it would be when the actual fee is deducted.
One option for firms is to simply take the delta between gross and net performance for each fund and use that percentage in marketing materials, noted the CFO and fund counsel at a private equity firm, but it is still a question firms are struggling with.
The new marketing rule eliminates the cash solicitation rule and allows the use of testimonials and endorsements with proper disclosures. For private equity firms, it’s not entirely certain whether testimonials of a portfolio company’s CEO would be permitted under the new rule. But speakers agreed that such endorsements and testimonials are outside the rule and don’t require disclosure.
However, one speaker said his firm is still taking a strict approach to the use of testimonials or endorsements from portfolio companies.
“While we don’t compensate those individuals, we do allow them to invest in our funds on a preferential basis. And so, I kind of feel like that’s fair game to disclose,” he noted.
PE sponsors are also struggling with the rule’s allowance for hypothetical performance and developing policies and procedures around it.
“One of the first things you need to do when developing a policy is to identify risk,” one CCO noted. “With hypothetical returns, I think the [SEC’s] adopting release is very helpful, especially when figuring out whether or not you end up detailing all of the risks you identified and what steps you’ve taken to try to mitigate them.”
Sponsors should be talking to investor relations professionals now about what assumptions are being made with hypotheticals, and why those assumptions are being used. The policies and procedures should be written to ensure that the hypothetical information is relevant to the financial situation, the investment guidelines or investment strategy, advised the general counsel.