Managing side letters post-PFAR

The Private Fund Adviser Rule (PFAR) was a landmark regulation to increase transparency and accountability within the private fund industry. However, the rule’s trajectory came to a definitive end on June 5, 2024 when the U.S. Court of Appeals for the Fifth Circuit vacated it. 

The court determined that the Securities and Exchange Commission (SEC) had overstepped its authority in implementing the PFAR, leading to its nullification. Despite options for appeal, the SEC chose not to pursue further legal action, solidifying this decision after the Supreme Court petition deadline passed on September 5, 2024.

Although the PFAR no longer holds regulatory weight, its principles remain significant, particularly for the management of side letters. 

These agreements often outline unique terms negotiated between fund managers and investors. Under the PFAR, funds would have faced stricter transparency and compliance standards, requiring innovative approaches to handle side letter provisions. 

It is worth noting that with the SEC's chair, Gary Gensler, stepping down ahead of Trump's inauguration in January, his successor is expected to push for a renewed deregulation drive.

However, while the rules have been vacated, the direction they set for disclosure and operational excellence are set to continue to influence the industry even with the changes ahead in SEC leadership.

Why PFAR Still Matters

The thinking behind PFAR sought to deal with conflicts of interest, lack of transparency, and ineffective governance mechanisms: all real problems investors will deal with from time to time.

Given that, PFAR can still be a useful signpost for fund managers striving for best practices:

• Disclosure and clear timelines build trust: Fund managers can still benefit from preemptively disclosing preferential terms offered through side letters, to build trust with potential investors. Experts point out that advisers should assess and provide appropriate disclosures to potential investors regarding current or potential side letter terms, including preferential redemption or information rights for investors meeting specific criteria, like committing substantial capital or seeding a new fund.
• Documentation Standards: Standardized and organized record-keeping was a key focus under the PFAR. Maintaining detailed and accessible documentation helps mitigate risks and streamline audits. Sticking to clear timelines for disclosures and compliance activities is efficient. 

How to Future-Proof Side Letters

PFAR’s regulatory framework has been vacated and we are set to enter an era of regulatory upheaval. But it would be a mistake to simply cast aside the best-practices and thinking generated by PFAR debates.

Proactively aligning processes with the more practical elements of PFAR can position funds for future compliance and operational excellence, and position funds closer to investor expectations, which are trending towards more transparency from private equity firms. 

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1. Preparing for Future Compliance Needs

The SEC is not alone in its focus on transparency and accountability – they operated as part of a global trend toward more rigorous oversight in the private funds space. Similar rules could emerge in the future, including through revisions to the EU’s UCITS and AIFMD regulations.

Fund managers should assess their operations and identify areas where compliance gaps may exist, or emerge. 

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2. Leveraging Legal AI for Side Letter Management

Technology can bridge the gap between current practices and future expectations. Solutions like Robin AI can assist with contract analysis, providing a leap forward in the speed and accuracy of highlighting key provisions and ensuring consistent terms application. 

Similarly, implementing searchable databases with AI overlays allows fund managers to track, retrieve, and analyse side letter provisions more efficiently.

Robin AI's tools can assist private equity firms in managing complex side letters. The platform uses AI to streamline contract management, enabling quick searches, clause comparisons, and automated report generation – typically around 90% faster than human lawyers working alone. 

Key features include instant access to obligations, setting reminders for critical dates, and reducing manual effort, helping firms not only avoid compliance risks, but to improve efficiency at the same time. 

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3. Establishing Best Practices

To align with PFAR-like standards, fund managers should adopt best practices, such as:

• Centralised Record-Keeping: Store all side letters and related communications in a secure, centralised system.
• Transparency Protocols: Develop policies for disclosing material terms to relevant stakeholders, even in the absence of formal mandates.
• Periodic Audits: Conduct regular reviews to ensure that side letter terms are consistently applied and compliant with existing agreements.

By using AI to assist with adopting enhanced disclosure practices and prioritising operational excellence, funds can strengthen investor confidence and future-proof operations.

The message for fund managers and compliance officers is clear: the end of PFAR does not mark the end of the need for robust compliance frameworks. Instead, it offers an opportunity to lead the industry in adopting forward-thinking practices. 

Now is the time to take action and ensure your fund is ready for whatever the regulatory landscape may bring. Robin AI can be the perfect tool to make sure funds stay future-proof.