Health systems could get more insight into how the private equity funds they invest in are performing under a U.S. Securities and Exchange Commission proposal.
The SEC wants to beef up the regulation of private fund advisers, those who put investors' money into private equity funds, hedge funds or venture capital funds. For the many health systems that have placed money in those areas, the changes would mean more transparency. For systems large enough to have in-house venture or private equity funds with outside investors, it would mean adhering to more rules as fund advisers.
"These are the biggest changes we've seen since the Dodd-Frank Act," said Matt Giordano, deputy practice leader in KPMG's U.S. Public Investment Management practice, referring to the post-Great Recession law that revamped the financial services industry. "It's a lot."
The SEC, which voted last week to propose the rules, said the changes to the Investment Advisers Act of 1940 would increase transparency, competition and efficiency in the $18 trillion private fund marketplace.
For their part, health systems told Modern Healthcare they were still reviewing the proposed rules and how their organizations would be affected. UPMC, a more than $20 billion academic health system in Pittsburgh, said it supports efforts to "require more disclosure and fair treatment for investors." The system said its venture capital arm, UPMC Enterprises, would not be affected because it does not have outside investors.
One of the proposal's biggest changes would be requiring advisers to provide quarterly statements on funds' performance, fees and expenses. That includes compensation paid by the fund's portfolio to the adviser and others. That means if a health system is invested in multiple funds, it will be able to see the expenses, fees and performance for funds A, B and C and compare them.
"It could help people be able to compare better and make better decisions in the future," said Daniel McAvoy, a shareholder with Polsinelli. "I think there is some real benefit to the investors."
The transparency could spark lower fees, Giordano said. Suddenly, if investors are receiving fee information from multiple private funds, it could increase competition and drive down rates.
Health system investors are also watching if the SEC moves forward with prohibiting preferential treatment to some investors that negatively affects others, unless the fund discloses the activity. Specific types of preferential treatment would be banned regardless of whether they're disclosed.
Preferential treatment often looks like large investors getting fee breaks, McAvoy said. If these rules take effect, it could give smaller investors the ability to negotiate lower fees. Or, advisers could do away with the fee breaks altogether.
What McAvoy thinks is more likely, though, is fund managers will institutionalize the fee breaks. So those who invest $10 million or less would pay a 2% management fee, for example, while those who invest $10 million to $50 million would pay 1.5%, and so on.
"Something like that we're it's baked into the documentation instead of each investor trying to negotiate using their own leverage," McAvoy said.
Preferential treatment of large investors has been a concern among some of Matt Wolf's health system clients. Wolf, a director and health care senior analyst with RSM, said those who invest $50 million worry they're getting a worse deal than those who invest $1 billion. Health systems with large retirement funds can also be the large investors getting the fee breaks, too.
The proposed rules would also prohibit fund advisers from engaging in activities "contrary to the public interest and protection of investors." That includes charging fees for unperformed services like accelerated monitoring or for investigating the adviser and receiving a credit extension from a fund client. Registered fund advisers would have to get annual audits for each private fund they advise that would have to be promptly distributed to investors.
Additionally, fund advisers would have to get outside evaluations on the fairness of any secondary transactions they want to undertake. That's when advisers offer investors the option to sell or exchange their interests for interest in another vehicle the adviser advises on. That requirement would be designed to put a check on advisers' potential conflicts of interest.
If the rules take effect, probably 90% of all private funds will need to amend their documents to comply, which will have sizable compliance costs, said Paul Pollock, a partner with Crowell & Morning. Most of the comments submitted as of Monday are supportive of the changes. One said, "it's about time the SEC sharpened its oversight on private equity funds."
Marc Ponchione, a senior partner with Debevoise & Plimpton, said in an interview that the "sheer magnitude" of the regulatory changes would be felt the most by small fund advisers, but even large managers would shoulder higher compliance costs.
"It might make running a fund extremely difficult going forward," he said.