April 29, 2022 - In the Comment Letter submission responding to the SEC’s Proposed Private Fund Disclosure Rule (“Proposed Rule”), the LSTA included an independent “Regulatory Impact Analysis” (“RIA”). We commissioned this RIA to demonstrate that the costs of the Proposed Rule would be far higher than the SEC estimated – and this is something that the SEC must address. Because the RIA is hard to interpret by anyone unaccustomed to bureaucratese, we offer a bit of a Rosetta Stone below.

When an agency like the SEC proposes to make a major regulatory change – roughly defined as one that has an annual effect of $100 million on the economy – it must undertake an RIA. The sixteen key elements that the Office of Management and Budget (“OMB”) recommend for an RIA are detailed at the bottom of this update.

The LSTA engaged John Dunham & Associates (“JDA”) to determine whether the SEC had met all these requirements. The short answer is no. The detailed analysis in the JDA report demonstrates that the SEC may have partially met the first element (a reasonably detailed description of the need of the rule), may have met the second element (an explanation of how the proposed regulatory action will meet the needs that the rule purports to address) and partially met the thirteenth element (quantifying and monetizing the anticipated costs from the regulatory action to the extent feasible).

The SEC did not meet the other elements and the JDA report used OMB standards (and excruciating detail!) to explain why. We provide an abridged recap (and a warning that the following material contains graphic mathematical content).

The SEC’s Proposed Rule contains five categories: Quarterly Reporting, Fund Audits, Fairness Opinions, Prohibited Activities and Preferential Treatment. For each category, JDA reviewed how the SEC analyzed the rule, how it should have analyzed the rule (and therefore what the costs actually would be for all funds) and assessed the costs and benefits of alternative approaches (in this case, the Null Alternative, the CLO Exemption Alternative and the Qualified Investor Alternative).

Now let’s use the SEC’s methodology and apply more real-world numbers. To develop more accurate cost assessments, the LSTA surveyed managers that had both CLOs and 40 Act loan funds, as well as accountants and collateral administrators. The results were as follows: An audit likely would range from $130,000 to $180,000 per year depending on the number of assets ($145,000 was assumed for the analysis); third party accounting fees would range 4-6 bps per year (5 bps was assumed for the analysis); one-time start-up costs would total 4 bps; maintaining books and records would be another 4-6 bps per year (4 bps was assumed for the analysis).

Applying these costs to relevant private funds, the audit cost would be $145,000*45,333 funds (that the SEC says needs audits); this comes to $6.573 billion. The SEC assumes the average private fund size is $29.84 million, therefore the third party accounting fees would be $676 million (5 bps *$29.83 million average fund size*45,333 funds). One-time start-up costs come to $541 million (4 bps *29.83 million average fund size*45,333 funds). Annual books and records fees would be $541 million (4 bps*29.83 million average fund size*45,333 funds). This totals to approximately $7.8 billion annually and another $541 million one-time fees.

Now, dividing $7.8 billion by all 753,417 funds documented by the SEC, that comes to approximate per fund annual costs of $8,700 for annual audit, $898 for third party reporting, $718 for books and records and an amortized upfront cost of $36. Total annual per fund cost for all SEC-documented funds for this approach is $10,430 or 3x the SEC estimate.

This process continues for the next 20 pages, including a cost-benefit analysis of exempting CLOs. (Note that because CLOs already disclose reams of information, there is very little benefit to the SEC’s disclosure requirements as they pertain to CLOs.) The bottom line, after all this government-sanctioned math, is that there is very little economic benefit of applying these rules to CLOs and there are very material costs.

Nine Key Elements OMB suggests that each agency include:

1. A reasonably detailed description of the need for the regulatory action;
2. An explanation of how the proposed regulatory action will meet that need;
3. An appropriate baseline assessment of how the world would look in the absence of the proposed action;
4. An assessment of potentially effective and reasonably feasible alternatives to the proposed regulatory action;
5. An explanation of why the planned regulatory action is preferable to the potential alternatives;
6. An uncertainty analysis;
7. A description and discussion of the distributive impacts of the potential alternatives;
8. A clear, plain-language executive summary including an accounting statement that summarizes the benefit and costs for the regulatory action;
9. A clear and transparent table presenting anticipated benefits and costs.

The OMB additionally states that each regulatory impact analysis also should:

1. Use the best reasonably obtainable scientific, technical economic information and present it in a clear, complete and unbiased manner;
2. Provide the data, sources and methods used in the RIA to the public via the internet;
3. Quantify and monetize the anticipated benefits from the regulatory action to the extent feasible;
4. Quantify and monetize the anticipated costs from the regulatory action to the extent feasible;
5. Explain and support how the benefits of the intended regulation justify its costs;
6. Ensure that the preferred option has the highest net benefits unless the law requires a different approach;
7. Use appropriate discount rates for benefits and costs expected to occur in the future.