Fairness Opinions Required for GP-Led Secondaries & Other New SEC Rules

In a Wednesday, August 23 open meeting, the Securities and Exchange Commission (SEC) voted to approve a set of new rules and amendments to the Investment Advisers Act of 1940 aimed at tightening the regulation of the $18 trillion private funds sector. These are the most significant changes to such rules since Dodd-Frank in 2010 and will undoubtedly reshape certain practices of private fund advisers.

Key Provisions

Under the adoption, private equity firms, hedge funds, and other private fund advisers registered with the SEC will be required to:

• Obtain a fairness opinion in connection with an adviser-led secondary transaction
• Obtain and distribute to investors an annual financial statement audit of each private fund it advises
• Provide investors (limited partners) with quarterly statements disclosing additional information regarding fund fees, expenses, and performance in addition to those paid by portfolio companies
• Prohibit all private fund advisers from providing investors with preferential treatment regarding redemptions (exiting a fund early) and timing of information via so-called side-letters unless full disclosure of such arrangements is made to all current and prospective investors (or when redemptions are required by law or regulation)

Regarding the preferential information rights, general partners (GPs) can still offer this information as long as they offer the same terms to every other LP in the fund. This wasn’t included in the proposal but is consistent with the intended goal from the SEC of helping to level the playing field and promote fair competition.

The SEC has given advisers one year to adapt to the new requirements, while those managing less than $1.5 billion have been given 18 months. The commission also included a legacy provision that will allow existing funds to be grandfathered in without having to renegotiate agreements with current investors.

What is a Fairness Opinion?

A fairness opinion is a statement from an independent financial expert that the consideration paid or received in a transaction is fair from a financial point of view. An opinion provided by an independent financial expert provides an objective evaluation and helps the recipient of the opinion, typically the GP of the fund, make an informed decision regarding the transaction. Although not a substitute for the GP’s own evaluation, independent fairness opinions help GPs demonstrate that they executed their fiduciary duty of care, acted in good faith, and conducted appropriate due diligence in connection with the transaction.

Why Is This Important Now?

Many private equity participants expect that traditional exit routes will remain challenging given public market volatility and uncertainty in interest rates and inflation. As such, funds will increasingly need to seek alternate liquidity options this year and beyond, including secondaries. According to data from PitchBook, secondary transactions reached record levels in the first half of 2022 before slowing in the second half of the year largely due to lower offering prices from potential buyers. Thus far in 2023, widening bid-ask spreads have been reported across several industries. This environment, paired with the amended SEC regulations, makes it imperative for private fund advisers to understand and obtain independent fairness opinions in connection with their secondary transactions.

How Can Centri Help?

As a result of these amendments, many fund advisers will need to transform their practices and implement new operational and management changes. We recommend private funds take a proactive stance to compliance by working with their team of advisers in accounting, fund administration, and legal to monitor changes and implement the new requirements.

With decades of experience and the support of our Opinion Committee, Centri’s opinion team is ideally suited to provide a truly independent, defensible fairness opinion that can help GP’s make prudent, well-informed decisions. If you are considering a secondary transaction, consult with your attorney and Centri’s opinion team early in the process to increase the efficiency of the process.

To the other provisions, we also have experience helping private equity firms and their portfolio companies navigate the changing regulatory landscape. Our cross-functional teams understand the impact this will have on the level of support required for portfolio valuation, accounting, and the internal controls over these procedures. This is especially important if your fund was not previously audited.

Contact us to arrange a call and speak with our team of experts who can give you the information needed to make informed decisions and help you implement industry best practices. We can partner with you and your advisers to navigate these new requirements successfully.