SEC Seeks More Comments on Controversial Custody Rule Plan

Nicolas Morgan, a partner with Paul Hastings and former SEC attorney, said that while the final private fund rules "shed some proposals that would have fundamentally interfered with the relationship between fund managers and limited partners, the rules continue to represent a watershed change in the SEC's level of involvement in those contractual relationships. And this particular group of investors, limited partners in hedge funds and private equity funds, are highly sophisticated with strong economic leverage."

In other words, Morgan added in an email, "these investors are fully capable of looking out for their own interests without the SEC dictating terms of their contractual relationships. Litigation challenging the rules appears likely."

As to the SEC reopening the comment period on the new custody rule plan, Morgan said that "given the fundamental changes the proposed custody rule would impose on advisors, the original comment period was woefully short."

In particular, Morgan continued, "the expansion of the custody rule over all assets is poorly conceived and will cause increased costs and decreased options for investors who might choose to use the services of an advisor who cannot afford to comply with the proposed rule. Hopefully, the additional time will enable the submission of further comments highlighting the rule's unintended negative consequences."

Bernstein noted in her statement that the new rule will require "all private fund advisers to undergo an annual audit under the conditions of the existing custody rule. We commend the Commission for reopening the safeguarding proposal to allow commenters to assess its interplay with the new audit rule."

The IAA, Bernstein said, "has pressed the SEC to consider its current rulemaking activity holistically and cumulatively and also provide meaningful opportunity for public feedback on how the various proposals interact with one another."

According to a fact sheet released by the SEC Wednesday, the new private funds rules require private fund advisers registered with the commission to:

• Provide investors with quarterly statements detailing information regarding private fund performance, fees and expenses;
• Obtain an annual audit for each private fund; and
• Obtain a fairness opinion or valuation opinion in connection with an advisor-led secondary transaction.

The Financial Services and General Government Appropriations bill, released by the House Appropriations Committee in mid-June, prohibits the SEC from using any funds to finalize or implement its new custody rule, the proposed Regulation Best Execution, and the agency's planned environmental, social and governance rule.

The SEC has said it plans to finalize the controversial new custody rule this year.