New SEC hedge fund rules not expected to trouble crypto firms

New rules instituted by the U.S. Securities and Exchange Commission (SEC) to regulate the private funds industry are not expected to affect crypto companies.

The new rules, voted 3-2 on Aug. 30 by SEC commissioners along party lines, will impact hedge funds, private equity, and certain venture capital funds.

However, they seem to have piqued the interest of asset managers overseeing crypto versions of private equity funds as they navigate the possible implications. 

Adam Guren, a co-founder of crypto-focused alternative asset manager Hunting Hill Digital, said the new requirements shouldn’t be overly burdensome for firms that have been diligent and kept up-to-date with the evolving regulations since earlier this year. 

He also pointed out that fund managers often use what’s known as a pass-through fee structure, which is not banned under the new SEC rules — though these rules require closer scrutiny of fees and annual fund audits. 

However, Guren warns that these rules would “materially increase costs,” particularly for smaller crypto fund managers.

SEC Commissioner Hester Peirce, a pro-crypto advocate, opined that the new rules could hinder the negotiating prowess of affluent, sophisticated investors. They “impose a retail-like framework on this very institutional marketplace,” he said.

However, SEC Chair Gary Gensler believes the new regulations will foster greater competition and efficiency by enhancing transparency and integrity in the private equity and hedge fund sector.

Among the fundamental changes introduced by the new rules will be restricting private equity firms and hedge funds from offering so-called side letters to clients. Side letters are special deals that give select clients better deal terms than others. 

Additionally, the rules require private equity firms to undergo annual audits and provide clients with quarterly reports detailing their funds’ performance.

Hedge fund groups sue SEC over new rules

Unsurprisingly, the new regulations have not gone unchallenged. On Sept. 1, several hedge funds and private equity firms filed a lawsuit in a federal appeals court arguing that the agency had overstepped its legal mandate when it issued the sweeping new rules.

Managed Funds Association (MFA), the trade association for the global alternative asset management industry, joined several other organizations — the National Association of Private Fund Managers, National Venture Capital Association, American Investment Council, Alternative Investment Management Association, and Loan Syndications & Trading Association — in filing a lawsuit in the U.S. Court of Appeals for the Fifth Circuit.

“The SEC has overstepped its statutory authority and core legislative mandate, leaving us no choice but to litigate,” said MFA President and CEO Bryan Corbett. “The Private Fund Adviser rule will harm investors, fund managers, and markets by increasing costs, undermining competition, and reducing investment opportunities for pensions, foundations, and endowments.”

However, the private funds industry, which manages an estimated $27 trillion in assets, was relieved that the SEC didn’t implement a version of regulations that would have made it easier for investors to sue asset managers for even minor investment breaches.

Gene Scalia and Helgi Walker of law firm Gibson, Dunn & Crutcher LLP are advising the private equity groups.