Episode 6: Put the Word Out: The SEC Is Back Up
In this episode of Asset Management Corner, Andrew Dean and Chris Mulligan discuss how the SEC has hit the ground running after a record-breaking federal government shutdown. Andrew and Chris discuss what that means, and give their first take on the newly released priorities from the Division of Examinations. Later, Andrew Chizzik and Stephanie E. Srulowitz, Co-Heads of Weil’s Private Funds Practice, join them to talk the state of the fundraising environment, important considerations for new advisers, and the current state of secondaries, all with a compliance overlay.
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Transcript
Andrew Dean: Hello and welcome back to Asset Management Corner. We are your hosts. I'm Andrew Dean. He's Chris Mulligan. We are partners at the law firm Weil. This is the podcast where we bring our experiences as former senior SEC officials in the Division of Exams and Enforcement and talk all things SEC and asset management. On today's podcast, we're joined by two of our partners, Andrew and Stephanie, in Weil's Private Funds Practice, who will talk to us about the state of the fundraising environment, important considerations for new advisors in the current state of secondaries, including GP-led secondaries. But first, Chris, some news. The shutdown is over. It's done. We're moving on. The SEC is back. And you know, the human part of this, obviously, like a lot of our friends and colleagues, it was a rough stretch for them. You and I remember back to the long stretch we had in 2018 to 2019. You know, you miss a few paychecks. And I remember there was a lot of stress for people around those times. So glad to see people sort of back at work. And what was pretty clear is that while the staff was off, they were really chomping at the bit. There was a lot of calls that we got, Chris, on day one on both the enforcement side and the exam side. We've heard that throughout the market. Like that's what we're hearing from folks. People have jumped back into their cases and their exams very quickly. We also saw at the end of last week, there were a number of cases brought against advisors, 6 advisors for misreps on Form ADV and not responding to SEC staff, which we also learned through a DOJ release that those related to a larger scheme, a ramp and dump scheme being operated. And so the SEC was able to get those cases on the book and part of a larger case. And Chris, also, big news, big news, I'm sure, you're excited. Exam priorities are out. Why don't you walk us through a little bit of what caught your eye?
Chris Mulligan: Absolutely. So November 17th, just a couple of days after the shutdown ended, the SEC very much explained that we are back and in a big way and got the priorities out. This is always an exciting moment for those of us in the exam community. And this year, I would say it's not terribly surprising. My digital takeaway is it's sort of what I expected it to be. The priorities focus on a lot of areas that apply widely to all types of different investment advisors, including private fund advisors, in addition to the usual topics, such as the marketing rule, custody rule, disclosures, cybersecurity, conflicts of interest, fiduciary duty, the sort of normal areas. There's a couple of new areas in here that I think are of great interest to folks, including Regulation SP. And I think if there could be any more signals the SEC is sending that the compliance date for the Reg SP amendments is not moving, or if it moves, it's going to move a relatively short amount of time, we're getting it here. The Division of Examinations have made clear that they're going to be looking for compliance with Regulation SP, and so we will see that. Also, some other interesting areas, looking at recently merged investment advisors. There's been a lot of M&A activity with investment advisors, and they flag that they are going to take a look at firms that have recently experienced that. They're also going to look at the intersection of alternative investments and retail. Also, not surprising, that has been signaled for quite some time that they are really looking at how private funds move into the retail space. Also, advisors to newly launched funds, advisors that have not advised private funds before, and advisors that have side-by-side accounts. So SMAs and private funds, advising both of them side-by-side is something that they're going to going to be looking at. Overall, a lot to digest. We're still digesting it, but not terribly surprising, but some interesting nuggets in there. One thing that was left out, crypto assets were not included in this year's priority, so that's interesting to note. But in general, it's the same types of issues that we've seen in the past with some slightly different places that they're emphasizing.
Andrew Dean: Yeah, Chris, my observation is the two structural changes from Last year's priorities that came out are, number one, the elimination of the section on private fund advisors. But as you said, that has been packaged, I think, a bit into the fiduciary duty section, the policy section. And even though there's a focus on retail in that context as per the priorities, what we also know from experience is that does not mean that the SEC won't continue efforts in the private fund advisor space. We know that there's still a focus on post-commitment management fee. A term that was used previously is not in this version, but it's still something the SEC exams and enforcement is looking at. And so we viewed these documents as sort of like a guidepost. It sort of signals to the staff what they should be focused on. It signals to industry what the SEC is thinking about. And so that's the way we generally think of it. So that's one on the private funds section was eliminated. And as you said, Chris, the crypto section was also eliminated. The other thing that I guess we should note is that end of the fiscal year was around the time of the shutdown. Now everyone's back. Chris, what's the dynamic now on the exam side? What goes on right after the fiscal year? Like what's happening now and where are things at?
Chris Mulligan: Yeah, so there were likely a lot of letters sent right before the end of the fiscal year. effectively counts as a closed examination.
Andrew Dean: Like deficiency letters?
Chris Mulligan: Deficiency letters sent out to registrants right before end of fiscal year. And that means that examiners are now trying to build their book for the upcoming year. That was delayed by, you know, 40 some odd days because of the shutdown. So I expect it to be a lot of examinations opened in the coming weeks and months as they try to build their book and get back up to those numbers for fiscal year 2026 as quickly as possible, which is the way the timing worked out. It was a little unusual because the previous shutdowns had happened a little bit later into the fiscal year. This happening right at the end of the fiscal year, you probably had a lot of closed exams, and now they're going to be looking to opening up a fair number of exams now.
Andrew Dean: Yeah, and on the enforcement side, when those deficiency letters get sent, to the extent they were all sent to the end of the fiscal year, sometimes there's a back and forth with exams before they became referrals. Sometimes they become referrals immediately to enforcement, sometimes to get closed immediately. I think what we will see are now that enforcement is back, we will see when that process will just take a little bit longer to work their way to actual enforcement referrals. There was obviously between that, there was a backlog of that happened at the end of the year. Plus you had the last 45 days of, you know, Chris, if you've been watching the news, lots going on in the news, a lot of stuff going on in the markets. And so whenever that happens, the SEC sees news articles, they see events, and both exams and enforcement will oftentimes get involved. So there's a lot of triaging happening right now where everyone in enforcement and exams is trying to figure out where the fires are. there any fires? Let's handle those things and then move on to our other cases. But there are, like I said, though, cases a lot of people did hear back on day one. I think that must have been an order that they were given is to like check in on your cases, make sure people know that we're back, you know, we're watching. And that is certainly what we've seen.
Chris Mulligan: All right, so the government is open, and we have two special guests here to talk about the state of the private fund formation market. Two partners who Andrew and I work with very closely all the time, the co-heads of Weil's private fund practice, Stephanie Srulowitz, based in New York. She's worked on a lot of transactions, including private fund advisors in connection with the formation, structuring, and negotiation of their investment funds. She also spent a lot of time working on complex secondary transactions, which is where we interact with Stephanie quite a bit and has represented basically every major client you can think of. So we're very excited to have her. We're also joined by the other co-head of Weil's Private Funds Practice, Andrew Chizzik. He has extensive experience representing private fund sponsors in launching and operating private investment funds. He also represents investment fund sponsors and their founders. And personnel in connection with economic sharing arrangements among persons in various employment and separation agreements also represented very prominent limited partners in connection with their investments in private fund advisors, as well as buyers and sellers. of secondary interest in private equity funds. Bottom line is, if you want to know anything about the state of the private fund formation market, these are the two people you want to talk with. Thanks so much for taking time out of your very busy day for visiting us on our podcast. Andrew and Stephanie, thank you so much for joining.
Stephanie Srulowitz: Thank you for having us on.
Andrew Chizzik: Excited to be here.
Chris Mulligan: Let's start with what's happening in the private fund formation market. We've read a lot of things that there was a fairly significant slowdown. last year. Obviously, it was red hot a couple of years ago and reading and hearing mixed signals today. But let's start with you, Andrew. What is the current state of the private funds market? What are the opportunities? What are the challenges that private fund advisors are facing as they're raising their new funds?
Andrew Chizzik: Thanks, Chris. If it's okay with you, let me start at a really high level with some macro thoughts, essentially that our industry over the generation that the four of us have been playing in it has really matured. And with a mature industry, we're finding a lot more consolidation, asset management, M&A, and we're finding so many players in the space now that folks need to be looking for places to differentiate themselves, to specialize, to find ways to accommodate their investors. And when you combine that mature industry with, as you referenced, Chris, challenging fundraising environment, one where distributions have been slowed, dispositions have been less frequent. You've definitely seen challenges. You've seen the leverage shift to investors. And it's now been a couple of years that we've been in this place. And Chris, you referenced how red hot it was a few years ago. We're not back there, and I don't know if we're going to get back there anytime soon. So what does that mean? It means sponsors need to be realistic about fundraising expectations, both in terms of numbers and substance and what they're going to face when they start talking to investors. And I think that kind of realism going into a fundraise, the size, how do we right size our target and how long is this going to take us? 12 months might have worked in the past. Does it need to be 18? Does it need to be more? So again, I think just being realistic is an important piece of advice for sponsors out there.
Chris Mulligan: That's really interesting. In terms of like metrics that limited partners look at, obviously what we work together on almost every day is the marketing rule, the SEC's marketing rule, which picks up all those sort of performance advertising. Obviously the tradition in closed end private equity funds has been IRR, that has been the traditional metric. Are you seeing any other metrics or any other sort of numbers that sort of limited partners are looking for today and maybe putting more emphasis on than they were a few years ago?
Andrew Chizzik: Yeah, I think Chris, and you had previously asked about opportunities, like I think these all fit together in that I do think investors are now more focused on DPI than ever before. Right. This notion of DPI being the new IRR, you know, clever tagline, but for a reason, right, that investors right now, because of the lack of distributions, the lack of dispositions, they are focused on cash. And therefore, I think they're more focused on DPI. And I think, you know, there's the intersection of that and the type of funds that they're looking to invest in. Right. So where are we seeing some strength? It's those places where investors look at and say, you know, yeah, there's some safety there and we're comfortable that the distributions are going to come. So maybe that's less traditional private equity funds and those, whether they're debt, whether they're infrastructure that we know have a track record of producing income. If it is private equity, is it those that are stable and secure, that have been around for a long time, that have a track record of making distributions? So I think the interplay there, Chris, with DPI is important and that's what investors are looking at. And then you also asked about opportunities. We can't get through, I'm sure, a podcast without referencing AI. Like I think that is the one place they didn't.
Chris Mulligan: We'd be arrested. We'd be arrested, Andrew.
Andrew Chizzik: Right? We can't have that. There would definitely be, you know. AI somewhere that would notice. So we have to do it. I think that's the one place, kind of where ESG might have been, a couple of years ago. AI now, there's a lot of things, investing in AI, the infrastructure around it, anything in that space, anything that can get it into the title. I'm sure, you know, you and Andrew focused on AI watching and not just greenwashing now. I think that's a space to watch as well.
Chris Mulligan: Yeah, no, absolutely. We're seeing a lot of focus on that from it seems like from investors, from general partners, and absolutely from the SEC exam staff and enforcement staff as well. So everyone's focused on AI across the board. So Stephanie, what are some terms that are really being negotiated right now? I remember my youth in the 2000s when I was a fund formation lawyer, I remember there were always a few terms that were always at issue and always seem to come down as you finalize fundraising. What are those issues today that investors really care about and there always seems to be a little friction over?
Stephanie Srulowitz: Well, the big that you'll always have be important to LPs. There's always going to be a focus on economics. There will always be a focus on remedies. There will always be a focus on conflict-related transactions. But a few specific trends we've seen of late where there's definitely been increased focus in a way maybe there wasn't in the past. One is expenses. I think for a long time, because of SEC focus on expenses, sponsors were really increasing their disclosure on what they're passing through to funds. But we've also seen now a trend in actually increasing expenses being passed through to funds, not just disclosure. And in particular, in the overhead area, you know, historically, the breakdown was manager bears overhead, fund bears everything else. And we're starting to see more managers that really started with the largest multi-fund managers who are really had sizable legal and accounting teams maybe trying to pass through some of that to their investors because they were relying less on outside counsel. But now we're starting to see smaller managers try to pass off some of their back office and middle office expenses to investors. And I think savvy investors are in some regards, you know, pushing back and really focusing on making sure they understand what those expenses look like and the magnitude and whether it's reasonable in light of the management fees that they're paying. We're also seeing an increased focus on borrowing with the proliferation of NAV facilities, which really are still being used in pretty specific ways to address specific issues. sponsors in fundraising have sometimes tried to increase their ability to use those when they don't necessarily know what their needs might be in the future. And so investors are definitely keeping an eye on that expansion of the ability to borrow. And depending on the sponsor, on leverage, and on the sponsor's intentions, definitely seeing more negotiation in that area to make sure that the borrowing provisions are appropriate for the strategy. And then the last one we're starting to see, which has really developed a lot in the last, say, 12 to 18 months, is With the proliferation, and we're going to talk a little bit more about continuation vehicles later on, but with that proliferation of those, now when we see blind pool funds being raised, we see investors who feel they have not necessarily been happy with some of the transactions they've been kind of dragged into in the past, looking for protections upfront. on if there is a future CV, not just that there'd be LPAC consent obtained, but that there'd be certain structural or economic protections built in, whether it be that they get a quote unquote status quo option guaranteed from the outset that they know they'll be able to stay in on the same terms. Sometimes they're looking for other protections as well along, whether it be making sure that there's a fairness opinion. And so that's been a really interesting development as well. And, from a sponsor's perspective, I think it's really important to make sure, again, if you're ever going to do a CV, you're going to want to make sure you've been really thoughtful about what it looks like, but not tying your hands because this is a market that's still evolving and you want to make sure you can do a transaction that, you know, might be 8 years down the line and will make sense at the time and you haven't been overly prescriptive when you have no idea what you might do as to what you've agreed to with your LP.
Andrew Dean: Stephanie, one of the things you mentioned was a focus on passing along fees. And I could tell you from the enforcement and the exam standpoint, that is a huge focus, is the extent to which the advisors are disclosed what is being passed along. And we see that both on the exam side and the enforcement side as well.
Chris Mulligan: Another hot issue on exams, especially with the new Form PF filings, are the continuation vehicles. And let's stay with that, Stephanie, because that is such a hot area, both from a regulatory perspective and in the market. What is driving this sort of rapid increase in GP-led secondaries. Do you have some thoughts on why we're seeing such an increase there?
Stephanie Srulowitz: Yeah, for sure. Just to give you some metrics, because it's pretty unbelievable. I mean, 2021 really felt like the year where these exploded, and there was about $125 billion in transaction volume. They're projecting $220 billion for 2025. So it's really, it's unbelievable. Look, I think that there's a few things driving it. One, you know, as Andrew was mentioning, exits have been challenging traditional exits. And so this is another tool toolkit to get money into LP's hands. LPs are looking for distributions. It's a way to get money out of a fund and get new investors in where traditional exit options like sales to strategics or IPOs just may not be available based on market conditions. There's also no stigma anymore with doing these. I think that sponsors who have name brands are comfortable doing these in a way that five years ago we were just starting to see. And 10 years ago, you really only did these transactions out of desperation. And so it's really, really, the market has completely changed. And so it's become also just a very, a tool that people are very happy to use if they think it makes sense. You're also seeing a lot of new entrants on the buy side. I think there's people still view it as a buyer market because they still think there's not enough capital for all the deals people are trying to do. But you're starting to see new entrants and new opportunities and there's specialization too. So if you're have a deal that's stressed, that's underwater, you know, there was a period where it was hard to do those deals because so many deals that were very, very attractive, very strong performers were entering the market. And so that's where the traditional secondaries players were turning their attention. But now you're starting to see specialists who can address those more challenged deals and who really like those deals and who negotiate kind of very different looking terms for CVs around more challenged assets. And so, you know, there's also opportunity with that specialization. It's easier for sponsors to find capital for their specific deals. And so it's become a really great tool. It's a great tool for follow on capital where funds are out of money. And so there's a lot of opportunity to either exit or add on in ways that you couldn't when your only options were like a full sale or an IPO.
Chris Mulligan: Yeah, no, that's great. And I was at the SEC 10 years ago when we started seeing those on the SEC side. And it's sort of improvement in process, improvement around disclosures. It's changed so much in the past 10 years. Can you talk about that importance of process and the things you think about, the regulatory issues you think about as you're putting these together?
Stephanie Srulowitz: Yeah, look, I think the two things that are incredibly important at a macro level for our clients to think about if they're a sponsor who's considering doing a CV are one, making sure to have always on that fiduciary lens. My existing LPs, these are my current LPs to whom I am a to do, Sherry? How am I going to do this transaction in a way that is optimal for them? There may be reasons that a sponsor needs to do the transaction as well. It may be what's best for the asset, but you also need to always have your core and LPs, who are the owners of the funds, that in mind. And that should always be helping inform decision making in terms of what options you're offering LPs, how you're running the process, what pricing you accept. So that's really important. You can't lose sight of that just because you're kind of excited excited to get off and running, and there are a lot of different voices at the table in these transactions. And the second thing is transparency. I think it's incredibly, incredibly important to have really good written disclosure that really accurately describes what is happening and what teases out the various conflicts that come up in these transactions, because they do differ depending on different choices that sponsors make and how they structure these. they do differ from transaction to transaction. And so I think really trying to nail down what are the conflicts that we see coming up and having really good disclosure, explaining those to the LPAC and to investors is critical.
Chris Mulligan: Yeah, thanks, Stephanie. That was really insightful and helpful to understand the status of a GP-led secondary market. A great thing here at Weil is we have such a wide variety of private fund advisors that we represent. We have very, very large advisors, but we also have, and we have a lot of mid-cap advisors, but we also have a lot of advisors that are just starting off, private fund advisors that are launching their first fund. And Andrew, are you seeing an increase or maybe it's just a while we're seeing an increase, but what's going on in that market and what are some things that new private fund advisors need to think about as they're launching their first or second fund?
Andrew Chizzik: Yeah, great question, Chris, and totally agree with you. We do some of the most mega funds out there and those are great and they're fun, but starting a business with someone it's kind of a separate challenge and something we all really, really enjoy. I do agree with you that notwithstanding some challenging market conditions, we are seeing emerging managers come back. We're seeing that here, we're seeing that in the data, and it's an exciting time for them and for us. The most important thing when we think about emerging managers is for them to understand that the decisions that they make as they're launching fund one, or frankly, even if they're doing a couple of fundless sponsor transactions in advance of that, that those decisions can reverberate for years and years to come. And therefore, they need to give them a lot of thought, and they need to be hiring advisors who are thinking not just about let's get fund one raised, but how is that going to impact funds two, three, and four? So I think for emerging managers trying to find counsel, whether that's law firm, placement agent, et cetera, who are like-minded and thinking about things the same way. The Weil approach, the advice we often give to emerging managers is to think about developing scarcity. And if they think that there could be $500 million of demand for their first time fund, what? Put 300 on the cover and go raise 400 and leave 100 on the table. Do it more quickly. Be happy with your terms because the last dollars are always the most expensive ones. And if that message resonates with folks finding advisors who are on the same page, if you feel differently about it, then find advisors who are on the same page as you. But recognizing sometimes there are, as an example, a placement agent who might be more focused on getting their fee for fund one, and let's just get it raised, and let's not worry so much about the terms. we can fix them down the road. But we've seen so many times people come to us on a fund two or three and say, hey, we wish we had thought of this when we were raising fund one.
Chris Mulligan: Yeah, that's great. So my final question is for both of you. I think for all of these types of advisors, why I like fund formation so much and why I think it's such an interesting space is it's this combination. And there's a lot of regulatory issues, but there's a lot of market issues too. And being on both sides, on the LP and GP side and sort of understanding what's happening in the market, can you speak to that side of it? We spent a lot of time on this podcast talking about the regulatory mandatory side, but there's such a big market component to this, understanding what other people are doing and combining that with where they are. To your point, Andrew, you're starting off, the market might be a little bit different for those advisors than it is for someone raising a $50 billion mega fund. Understanding the intersection of market and what your advisor is trying to accomplish, can both of you speak to that and the importance of understanding that part of it?
Stephanie Srulowitz: Yeah, I think that really is one of the most interesting things about being a private funds lawyer. we are always in the market raising funds with our clients. But our clients are only in the market every few years if they don't have multiple strategies. So it's not something that they're seeing with the same volume. They also only see their own documents. And we see lots of different funds. And so we get the opportunity to give a lot of commercial advice and really help our clients know what the trends are, know where there's pressure, know where the opportunities are. And I think it's one of the most interesting things about my job that I get to counsel their clients, not just on the legal issues they face, but on their businesses. And I think it's one of our biggest responsibilities because we really need to stay on top of what is happening so our clients can do the same.
Andrew Chizzik: Yeah, and I totally agree with everything Stephanie just said. And Chris, I think you framed the question really well, that it's the import of understanding market. And I think that's kind of a baseline that your funds lawyers should have. But for those that are looking for fund counsel, I think it's trying to find someone that you trust can take that market data and provide good judgment and good counsel on top of the market, right? Like people can go take 100 fund documents and have AI kind of run it through the system and kind of give you, okay, here's the market on management fees, right? But how does that interplay, how does that intersect with where the fund is in the marketplace today and what they're trying to accomplish and the message they're trying to send? So I think that's what sponsors should be thinking about.
Stephanie Srulowitz: That's such a great point, Andrew, because I think one of the places where we really think we add value is that helping our clients understand like market is really, it's a data point, but different clients have different goals and different priorities. And it's really helping them achieve those while being aware and kind of knowing the contours of market because no document is 100%. middle of the fairway perfectly market. And so you really want to focus on trying to win those points, quote unquote, that are really core to your clients' priorities in the way they want to run their business and not fixate just because something might be market or they maybe got a good deal last time on things that are not as critical to them. And I think that's where we can add a lot of value.
Chris Mulligan: Well, Andrew, Stephanie, we'll leave it there. Thank you so much for coming. I know you have a very busy schedule, so we really appreciate you spending a few minutes chatting with us. I promise our next podcast will be 100% about That's all we'll talk about. But thank you so much for joining us today.
Andrew Chizzik: Thank you for having us. This was fun.
Stephanie Srulowitz: Absolutely. Thank you.
Andrew Dean: Thanks, guys. Thanks to our guests, Andrew and Stephanie. That was a nice conversation. And thanks for joining us for another episode of Asset Management Corner, and we'll catch you next time.
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Chris Mulligan: Absolutely. So November 17th, just a couple of days after the shutdown ended, the SEC very much explained that we are back and in a big way and got the priorities out. This is always an exciting moment for those of us in the exam community. And this year, I would say it's not terribly surprising. My digital takeaway is it's sort of what I expected it to be. The priorities focus on a lot of areas that apply widely to all types of different investment advisors, including private fund advisors, in addition to the usual topics, such as the marketing rule, custody rule, disclosures, cybersecurity, conflicts of interest, fiduciary duty, the sort of normal areas. There's a couple of new areas in here that I think are of great interest to folks, including Regulation SP. And I think if there could be any more signals the SEC is sending that the compliance date for the Reg SP amendments is not moving, or if it moves, it's going to move a relatively short amount of time, we're getting it here. The Division of Examinations have made clear that they're going to be looking for compliance with Regulation SP, and so we will see that. Also, some other interesting areas, looking at recently merged investment advisors. There's been a lot of M&A activity with investment advisors, and they flag that they are going to take a look at firms that have recently experienced that. They're also going to look at the intersection of alternative investments and retail. Also, not surprising, that has been signaled for quite some time that they are really looking at how private funds move into the retail space. Also, advisors to newly launched funds, advisors that have not advised private funds before, and advisors that have side-by-side accounts. So SMAs and private funds, advising both of them side-by-side is something that they're going to going to be looking at. Overall, a lot to digest. We're still digesting it, but not terribly surprising, but some interesting nuggets in there. One thing that was left out, crypto assets were not included in this year's priority, so that's interesting to note. But in general, it's the same types of issues that we've seen in the past with some slightly different places that they're emphasizing.
Andrew Dean: Yeah, Chris, my observation is the two structural changes from Last year's priorities that came out are, number one, the elimination of the section on private fund advisors. But as you said, that has been packaged, I think, a bit into the fiduciary duty section, the policy section. And even though there's a focus on retail in that context as per the priorities, what we also know from experience is that does not mean that the SEC won't continue efforts in the private fund advisor space. We know that there's still a focus on post-commitment management fee. A term that was used previously is not in this version, but it's still something the SEC exams and enforcement is looking at. And so we viewed these documents as sort of like a guidepost. It sort of signals to the staff what they should be focused on. It signals to industry what the SEC is thinking about. And so that's the way we generally think of it. So that's one on the private funds section was eliminated. And as you said, Chris, the crypto section was also eliminated. The other thing that I guess we should note is that end of the fiscal year was around the time of the shutdown. Now everyone's back. Chris, what's the dynamic now on the exam side? What goes on right after the fiscal year? Like what's happening now and where are things at?
Chris Mulligan: Yeah, so there were likely a lot of letters sent right before the end of the fiscal year. effectively counts as a closed examination.
Andrew Dean: Like deficiency letters?
Chris Mulligan: Deficiency letters sent out to registrants right before end of fiscal year. And that means that examiners are now trying to build their book for the upcoming year. That was delayed by, you know, 40 some odd days because of the shutdown. So I expect it to be a lot of examinations opened in the coming weeks and months as they try to build their book and get back up to those numbers for fiscal year 2026 as quickly as possible, which is the way the timing worked out. It was a little unusual because the previous shutdowns had happened a little bit later into the fiscal year. This happening right at the end of the fiscal year, you probably had a lot of closed exams, and now they're going to be looking to opening up a fair number of exams now.
Andrew Dean: Yeah, and on the enforcement side, when those deficiency letters get sent, to the extent they were all sent to the end of the fiscal year, sometimes there's a back and forth with exams before they became referrals. Sometimes they become referrals immediately to enforcement, sometimes to get closed immediately. I think what we will see are now that enforcement is back, we will see when that process will just take a little bit longer to work their way to actual enforcement referrals. There was obviously between that, there was a backlog of that happened at the end of the year. Plus you had the last 45 days of, you know, Chris, if you've been watching the news, lots going on in the news, a lot of stuff going on in the markets. And so whenever that happens, the SEC sees news articles, they see events, and both exams and enforcement will oftentimes get involved. So there's a lot of triaging happening right now where everyone in enforcement and exams is trying to figure out where the fires are. there any fires? Let's handle those things and then move on to our other cases. But there are, like I said, though, cases a lot of people did hear back on day one. I think that must have been an order that they were given is to like check in on your cases, make sure people know that we're back, you know, we're watching. And that is certainly what we've seen.
Chris Mulligan: All right, so the government is open, and we have two special guests here to talk about the state of the private fund formation market. Two partners who Andrew and I work with very closely all the time, the co-heads of Weil's private fund practice, Stephanie Srulowitz, based in New York. She's worked on a lot of transactions, including private fund advisors in connection with the formation, structuring, and negotiation of their investment funds. She also spent a lot of time working on complex secondary transactions, which is where we interact with Stephanie quite a bit and has represented basically every major client you can think of. So we're very excited to have her. We're also joined by the other co-head of Weil's Private Funds Practice, Andrew Chizzik. He has extensive experience representing private fund sponsors in launching and operating private investment funds. He also represents investment fund sponsors and their founders. And personnel in connection with economic sharing arrangements among persons in various employment and separation agreements also represented very prominent limited partners in connection with their investments in private fund advisors, as well as buyers and sellers. of secondary interest in private equity funds. Bottom line is, if you want to know anything about the state of the private fund formation market, these are the two people you want to talk with. Thanks so much for taking time out of your very busy day for visiting us on our podcast. Andrew and Stephanie, thank you so much for joining.
Stephanie Srulowitz: Thank you for having us on.
Andrew Chizzik: Excited to be here.
Chris Mulligan: Let's start with what's happening in the private fund formation market. We've read a lot of things that there was a fairly significant slowdown. last year. Obviously, it was red hot a couple of years ago and reading and hearing mixed signals today. But let's start with you, Andrew. What is the current state of the private funds market? What are the opportunities? What are the challenges that private fund advisors are facing as they're raising their new funds?
Andrew Chizzik: Thanks, Chris. If it's okay with you, let me start at a really high level with some macro thoughts, essentially that our industry over the generation that the four of us have been playing in it has really matured. And with a mature industry, we're finding a lot more consolidation, asset management, M&A, and we're finding so many players in the space now that folks need to be looking for places to differentiate themselves, to specialize, to find ways to accommodate their investors. And when you combine that mature industry with, as you referenced, Chris, challenging fundraising environment, one where distributions have been slowed, dispositions have been less frequent. You've definitely seen challenges. You've seen the leverage shift to investors. And it's now been a couple of years that we've been in this place. And Chris, you referenced how red hot it was a few years ago. We're not back there, and I don't know if we're going to get back there anytime soon. So what does that mean? It means sponsors need to be realistic about fundraising expectations, both in terms of numbers and substance and what they're going to face when they start talking to investors. And I think that kind of realism going into a fundraise, the size, how do we right size our target and how long is this going to take us? 12 months might have worked in the past. Does it need to be 18? Does it need to be more? So again, I think just being realistic is an important piece of advice for sponsors out there.
Chris Mulligan: That's really interesting. In terms of like metrics that limited partners look at, obviously what we work together on almost every day is the marketing rule, the SEC's marketing rule, which picks up all those sort of performance advertising. Obviously the tradition in closed end private equity funds has been IRR, that has been the traditional metric. Are you seeing any other metrics or any other sort of numbers that sort of limited partners are looking for today and maybe putting more emphasis on than they were a few years ago?
Andrew Chizzik: Yeah, I think Chris, and you had previously asked about opportunities, like I think these all fit together in that I do think investors are now more focused on DPI than ever before. Right. This notion of DPI being the new IRR, you know, clever tagline, but for a reason, right, that investors right now, because of the lack of distributions, the lack of dispositions, they are focused on cash. And therefore, I think they're more focused on DPI. And I think, you know, there's the intersection of that and the type of funds that they're looking to invest in. Right. So where are we seeing some strength? It's those places where investors look at and say, you know, yeah, there's some safety there and we're comfortable that the distributions are going to come. So maybe that's less traditional private equity funds and those, whether they're debt, whether they're infrastructure that we know have a track record of producing income. If it is private equity, is it those that are stable and secure, that have been around for a long time, that have a track record of making distributions? So I think the interplay there, Chris, with DPI is important and that's what investors are looking at. And then you also asked about opportunities. We can't get through, I'm sure, a podcast without referencing AI. Like I think that is the one place they didn't.
Chris Mulligan: We'd be arrested. We'd be arrested, Andrew.
Andrew Chizzik: Right? We can't have that. There would definitely be, you know. AI somewhere that would notice. So we have to do it. I think that's the one place, kind of where ESG might have been, a couple of years ago. AI now, there's a lot of things, investing in AI, the infrastructure around it, anything in that space, anything that can get it into the title. I'm sure, you know, you and Andrew focused on AI watching and not just greenwashing now. I think that's a space to watch as well.
Chris Mulligan: Yeah, no, absolutely. We're seeing a lot of focus on that from it seems like from investors, from general partners, and absolutely from the SEC exam staff and enforcement staff as well. So everyone's focused on AI across the board. So Stephanie, what are some terms that are really being negotiated right now? I remember my youth in the 2000s when I was a fund formation lawyer, I remember there were always a few terms that were always at issue and always seem to come down as you finalize fundraising. What are those issues today that investors really care about and there always seems to be a little friction over?
Stephanie Srulowitz: Well, the big that you'll always have be important to LPs. There's always going to be a focus on economics. There will always be a focus on remedies. There will always be a focus on conflict-related transactions. But a few specific trends we've seen of late where there's definitely been increased focus in a way maybe there wasn't in the past. One is expenses. I think for a long time, because of SEC focus on expenses, sponsors were really increasing their disclosure on what they're passing through to funds. But we've also seen now a trend in actually increasing expenses being passed through to funds, not just disclosure. And in particular, in the overhead area, you know, historically, the breakdown was manager bears overhead, fund bears everything else. And we're starting to see more managers that really started with the largest multi-fund managers who are really had sizable legal and accounting teams maybe trying to pass through some of that to their investors because they were relying less on outside counsel. But now we're starting to see smaller managers try to pass off some of their back office and middle office expenses to investors. And I think savvy investors are in some regards, you know, pushing back and really focusing on making sure they understand what those expenses look like and the magnitude and whether it's reasonable in light of the management fees that they're paying. We're also seeing an increased focus on borrowing with the proliferation of NAV facilities, which really are still being used in pretty specific ways to address specific issues. sponsors in fundraising have sometimes tried to increase their ability to use those when they don't necessarily know what their needs might be in the future. And so investors are definitely keeping an eye on that expansion of the ability to borrow. And depending on the sponsor, on leverage, and on the sponsor's intentions, definitely seeing more negotiation in that area to make sure that the borrowing provisions are appropriate for the strategy. And then the last one we're starting to see, which has really developed a lot in the last, say, 12 to 18 months, is With the proliferation, and we're going to talk a little bit more about continuation vehicles later on, but with that proliferation of those, now when we see blind pool funds being raised, we see investors who feel they have not necessarily been happy with some of the transactions they've been kind of dragged into in the past, looking for protections upfront. on if there is a future CV, not just that there'd be LPAC consent obtained, but that there'd be certain structural or economic protections built in, whether it be that they get a quote unquote status quo option guaranteed from the outset that they know they'll be able to stay in on the same terms. Sometimes they're looking for other protections as well along, whether it be making sure that there's a fairness opinion. And so that's been a really interesting development as well. And, from a sponsor's perspective, I think it's really important to make sure, again, if you're ever going to do a CV, you're going to want to make sure you've been really thoughtful about what it looks like, but not tying your hands because this is a market that's still evolving and you want to make sure you can do a transaction that, you know, might be 8 years down the line and will make sense at the time and you haven't been overly prescriptive when you have no idea what you might do as to what you've agreed to with your LP.
Andrew Dean: Stephanie, one of the things you mentioned was a focus on passing along fees. And I could tell you from the enforcement and the exam standpoint, that is a huge focus, is the extent to which the advisors are disclosed what is being passed along. And we see that both on the exam side and the enforcement side as well.
Chris Mulligan: Another hot issue on exams, especially with the new Form PF filings, are the continuation vehicles. And let's stay with that, Stephanie, because that is such a hot area, both from a regulatory perspective and in the market. What is driving this sort of rapid increase in GP-led secondaries. Do you have some thoughts on why we're seeing such an increase there?
Stephanie Srulowitz: Yeah, for sure. Just to give you some metrics, because it's pretty unbelievable. I mean, 2021 really felt like the year where these exploded, and there was about $125 billion in transaction volume. They're projecting $220 billion for 2025. So it's really, it's unbelievable. Look, I think that there's a few things driving it. One, you know, as Andrew was mentioning, exits have been challenging traditional exits. And so this is another tool toolkit to get money into LP's hands. LPs are looking for distributions. It's a way to get money out of a fund and get new investors in where traditional exit options like sales to strategics or IPOs just may not be available based on market conditions. There's also no stigma anymore with doing these. I think that sponsors who have name brands are comfortable doing these in a way that five years ago we were just starting to see. And 10 years ago, you really only did these transactions out of desperation. And so it's really, really, the market has completely changed. And so it's become also just a very, a tool that people are very happy to use if they think it makes sense. You're also seeing a lot of new entrants on the buy side. I think there's people still view it as a buyer market because they still think there's not enough capital for all the deals people are trying to do. But you're starting to see new entrants and new opportunities and there's specialization too. So if you're have a deal that's stressed, that's underwater, you know, there was a period where it was hard to do those deals because so many deals that were very, very attractive, very strong performers were entering the market. And so that's where the traditional secondaries players were turning their attention. But now you're starting to see specialists who can address those more challenged deals and who really like those deals and who negotiate kind of very different looking terms for CVs around more challenged assets. And so, you know, there's also opportunity with that specialization. It's easier for sponsors to find capital for their specific deals. And so it's become a really great tool. It's a great tool for follow on capital where funds are out of money. And so there's a lot of opportunity to either exit or add on in ways that you couldn't when your only options were like a full sale or an IPO.
Chris Mulligan: Yeah, no, that's great. And I was at the SEC 10 years ago when we started seeing those on the SEC side. And it's sort of improvement in process, improvement around disclosures. It's changed so much in the past 10 years. Can you talk about that importance of process and the things you think about, the regulatory issues you think about as you're putting these together?
Stephanie Srulowitz: Yeah, look, I think the two things that are incredibly important at a macro level for our clients to think about if they're a sponsor who's considering doing a CV are one, making sure to have always on that fiduciary lens. My existing LPs, these are my current LPs to whom I am a to do, Sherry? How am I going to do this transaction in a way that is optimal for them? There may be reasons that a sponsor needs to do the transaction as well. It may be what's best for the asset, but you also need to always have your core and LPs, who are the owners of the funds, that in mind. And that should always be helping inform decision making in terms of what options you're offering LPs, how you're running the process, what pricing you accept. So that's really important. You can't lose sight of that just because you're kind of excited excited to get off and running, and there are a lot of different voices at the table in these transactions. And the second thing is transparency. I think it's incredibly, incredibly important to have really good written disclosure that really accurately describes what is happening and what teases out the various conflicts that come up in these transactions, because they do differ depending on different choices that sponsors make and how they structure these. they do differ from transaction to transaction. And so I think really trying to nail down what are the conflicts that we see coming up and having really good disclosure, explaining those to the LPAC and to investors is critical.
Chris Mulligan: Yeah, thanks, Stephanie. That was really insightful and helpful to understand the status of a GP-led secondary market. A great thing here at Weil is we have such a wide variety of private fund advisors that we represent. We have very, very large advisors, but we also have, and we have a lot of mid-cap advisors, but we also have a lot of advisors that are just starting off, private fund advisors that are launching their first fund. And Andrew, are you seeing an increase or maybe it's just a while we're seeing an increase, but what's going on in that market and what are some things that new private fund advisors need to think about as they're launching their first or second fund?
Andrew Chizzik: Yeah, great question, Chris, and totally agree with you. We do some of the most mega funds out there and those are great and they're fun, but starting a business with someone it's kind of a separate challenge and something we all really, really enjoy. I do agree with you that notwithstanding some challenging market conditions, we are seeing emerging managers come back. We're seeing that here, we're seeing that in the data, and it's an exciting time for them and for us. The most important thing when we think about emerging managers is for them to understand that the decisions that they make as they're launching fund one, or frankly, even if they're doing a couple of fundless sponsor transactions in advance of that, that those decisions can reverberate for years and years to come. And therefore, they need to give them a lot of thought, and they need to be hiring advisors who are thinking not just about let's get fund one raised, but how is that going to impact funds two, three, and four? So I think for emerging managers trying to find counsel, whether that's law firm, placement agent, et cetera, who are like-minded and thinking about things the same way. The Weil approach, the advice we often give to emerging managers is to think about developing scarcity. And if they think that there could be $500 million of demand for their first time fund, what? Put 300 on the cover and go raise 400 and leave 100 on the table. Do it more quickly. Be happy with your terms because the last dollars are always the most expensive ones. And if that message resonates with folks finding advisors who are on the same page, if you feel differently about it, then find advisors who are on the same page as you. But recognizing sometimes there are, as an example, a placement agent who might be more focused on getting their fee for fund one, and let's just get it raised, and let's not worry so much about the terms. we can fix them down the road. But we've seen so many times people come to us on a fund two or three and say, hey, we wish we had thought of this when we were raising fund one.
Chris Mulligan: Yeah, that's great. So my final question is for both of you. I think for all of these types of advisors, why I like fund formation so much and why I think it's such an interesting space is it's this combination. And there's a lot of regulatory issues, but there's a lot of market issues too. And being on both sides, on the LP and GP side and sort of understanding what's happening in the market, can you speak to that side of it? We spent a lot of time on this podcast talking about the regulatory mandatory side, but there's such a big market component to this, understanding what other people are doing and combining that with where they are. To your point, Andrew, you're starting off, the market might be a little bit different for those advisors than it is for someone raising a $50 billion mega fund. Understanding the intersection of market and what your advisor is trying to accomplish, can both of you speak to that and the importance of understanding that part of it?
Stephanie Srulowitz: Yeah, I think that really is one of the most interesting things about being a private funds lawyer. we are always in the market raising funds with our clients. But our clients are only in the market every few years if they don't have multiple strategies. So it's not something that they're seeing with the same volume. They also only see their own documents. And we see lots of different funds. And so we get the opportunity to give a lot of commercial advice and really help our clients know what the trends are, know where there's pressure, know where the opportunities are. And I think it's one of the most interesting things about my job that I get to counsel their clients, not just on the legal issues they face, but on their businesses. And I think it's one of our biggest responsibilities because we really need to stay on top of what is happening so our clients can do the same.
Andrew Chizzik: Yeah, and I totally agree with everything Stephanie just said. And Chris, I think you framed the question really well, that it's the import of understanding market. And I think that's kind of a baseline that your funds lawyers should have. But for those that are looking for fund counsel, I think it's trying to find someone that you trust can take that market data and provide good judgment and good counsel on top of the market, right? Like people can go take 100 fund documents and have AI kind of run it through the system and kind of give you, okay, here's the market on management fees, right? But how does that interplay, how does that intersect with where the fund is in the marketplace today and what they're trying to accomplish and the message they're trying to send? So I think that's what sponsors should be thinking about.
Stephanie Srulowitz: That's such a great point, Andrew, because I think one of the places where we really think we add value is that helping our clients understand like market is really, it's a data point, but different clients have different goals and different priorities. And it's really helping them achieve those while being aware and kind of knowing the contours of market because no document is 100%. middle of the fairway perfectly market. And so you really want to focus on trying to win those points, quote unquote, that are really core to your clients' priorities in the way they want to run their business and not fixate just because something might be market or they maybe got a good deal last time on things that are not as critical to them. And I think that's where we can add a lot of value.
Chris Mulligan: Well, Andrew, Stephanie, we'll leave it there. Thank you so much for coming. I know you have a very busy schedule, so we really appreciate you spending a few minutes chatting with us. I promise our next podcast will be 100% about That's all we'll talk about. But thank you so much for joining us today.
Andrew Chizzik: Thank you for having us. This was fun.
Stephanie Srulowitz: Absolutely. Thank you.
Andrew Dean: Thanks, guys. Thanks to our guests, Andrew and Stephanie. That was a nice conversation. And thanks for joining us for another episode of Asset Management Corner, and we'll catch you next time.
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