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As we reach the midpoint of 2024, the SEC’s enforcement actions continue to shape the private funds industry. From the continuing off-channel recordkeeping sweep to heightened scrutiny on AI claims, fiduciary obligations of fund managers, and insider trading, the SEC is as vigilant as ever. Compounding these efforts are significant…

The SEC’s recent settlement involving a “pay-to-play” rule violation by a private equity firm is a timely reminder for fund managers, especially with the November elections approaching. 

As a refresher, Rule 206(4)-5 of the Investment Advisers Act – known as the “pay to play” rule – prohibits investment advisers from receiving compensation for providing advisory services to state and municipal entities for two years after the adviser or one of its “covered associates” makes certain political contribution to candidates for public office. Note that the SEC Enforcement Division staff periodically reviews public campaign contribution reports (which are publicly available online) to identify donations by individuals associated with investment advisers.

The SEC’s new and proposed rules on cybersecurity and cyber-incident reporting will have a dual impact on private investment advisers and funds. 

First, the proposal by the SEC will impose cybersecurity related obligations on investment advisers, registered investment companies and business development companies, with a final rule in this sector (the “adviser cybersecurity rule”) expected in April 2024. 

In its final Private Fund Adviser Rules adopted last year, the SEC dropped one of the more controversial proposed rules—the proposal to prohibit contractual exculpation or indemnification provisions that would shield or indemnify the adviser in matters involving the adviser’s negligence or breach of fiduciary duty.  On its face, this was a concession to the fund management industry. However, the Rule’s Adopting Release asserted that the SEC believed the provision was not needed because the antifraud provisions of the Advisers Act already prohibited certain provisions that would be covered by the proposal. Because the SEC’s interpretation was based on current law (there is no grandfathering or “implementation date” in the future), we predict that contractual indemnification or exculpation provisions will remain firmly in the SEC’s sights for 2024. SEC exams and enforcement proceedings are likely to focus on these provisions, and they may be implicated in GP/LP disputes as well.

Adviser-led secondary transactions have seen explosive growth over the last five years.  That growth has brought increased regulatory concerns over the conflicts of interests inherent in these transactions and a perceived lack of transparency into this market.  New SEC rules adopted in 2023 will arm regulators with additional tools to identify, exam and investigate market practices.  It is therefore critical for managers running an adviser-led secondary transaction to not only comply with the new rules as they become effective but to structure any such transaction with the SEC’s concerns in mind. 

2023’s excitement for generative artificial intelligence (AI) prompted the SEC to respond on multiple fronts – stump speeches, rulemaking, new exam priorities and sweeps and previewing potential enforcement actions. SEC Chair Gary Gensler raised concerns regarding potential conflicts and investor harm resulting from the proliferation of AI and warned that an AI-caused financial crisis is nearly unavoidable absent regulation. The SEC adopted a number of initiatives in 2023 to respond to these perceived risks. 

ESG continues to be a hot topic for 2024 for investors and regulators alike. The specific concerns investors and regulators have – and what they expect to develop over the coming months – differ, however, across jurisdictions, including because of the different maturity of existing regulation between the EU/UK and the US.

In a wave of SEC rulemaking this past year, representing a “new world order” event akin to Dodd-Frank, the SEC has provided itself with a fresh set of tools to increase regulatory and enforcement scrutiny on private funds. Among other things, certain of the rules could result in fundamental changes to market practices and greater disclosure to LPs. While ongoing litigation will determine the fates of the Private Fund Adviser Rules, the Short Sale Disclosure Rule, and the Securities Lending Rule, and while other rules are awaiting final adoption, the SEC concerns underlying the rulemaking will continue regardless.   

To understand the litigation and regulatory risks that are coming in 2024 for private capital, it is helpful to look back briefly on recent events. Arguably, the single most important event over the last 18 months was the rapid increase in interest rates by the central banks in the United States, England, and Europe. From March 2022 to August 2023, the Federal Reserve increased interest rates at the fastest clip in more than 40 years, to break inflation that had reached the highest levels since the 1970s.

The SEC’s recent enforcement settlement involving a fund manager highlights the SEC’s focus on an investor’s “control purpose” triggering the requirement to file on a Schedule 13D as opposed to a short-form 13G. At issue was HG Vora Capital Management’s 5% interest in a public company, and whether it had…