What You Need to Know About the SEC’s New Private Fund Rules

Published: Aug 25, 2023
By: Nevil Thakkar
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Introduction

On August 23, 2023, the Securities and Exchange Commission (“SEC”) voted to adopt amendments to Private Fund Manager Rules, which is the confidential reporting form for certain SEC-registered investment advisers to private funds. In announcing the amendments, the SEC indicated that its goal in adopting the new rules is to enhance ability to assess systemic risk and bolster its oversight of private fund advisers consistent with its mission of investor protection.

The asset management industry’s take on these amendments is that they represent tough new rules that will increase regulatory compliance obligations and reporting requirements for private fund advisers. Critics, however, complain that the new rules are watered down from what the SEC originally proposed in February 2022, which would have made it easier for investors to sue for negligence when funds lost money or deals went bad. Notably, the final vote approving the amendments was split 3-2 along party lines. For its part, the SEC’s position is that the final rules strike the right balance between advancing its investor protection mandate and imposing costs and burdens on the industry.

How will it impact private fund advisers?

The amendments to Private Fund Manager Rules can be categorized as follows:

1. Quarterly Statements

Fee and Expenses Disclosure in a Detailed Tabular Format: This rule requires investment adviser information regarding the fund’s fees and expenses and any compensation paid or allocated to the adviser or its related persons by the fund, as well as any compensation paid or allocated by the fund’s underlying portfolio investments.
Performance Disclosure: Requires advisers to include standardized fund performance information in each quarterly statement provided to fund investors. The form and type of disclosure may vary based on whether fund is liquid and illiquid.

2. Mandatory Private Fund Audits

Annually within 120 days of the private fund’s fiscal year-end and promptly upon liquidation, the private fund’s audited financial statements (under U.S. GAAP) are delivered to investors in the private fund (the mandatory private fund adviser audit rule would effectively eliminate the surprise examination option under the custody rule).

3. Preferential Treatment

The rule prohibits all private fund advisers, regardless of whether they are registered with the SEC, from granting an investor preferential treatment (prohibited preferential redemptions) or providing information to an investor (prohibited preferential transparency) which materially or negatively impacts the interests of the other investors in that private fund or in a substantially similar pool of assets.
Advisers are prohibited from providing any other preferential treatment to any investor in the private fund unless the adviser delivers certain written disclosures to prospective and current investors regarding all preferential treatment the adviser or its related persons provide to other investors in the same fund.

4. Adviser Led Secondaries

SEC-registered advisers are required to satisfy certain requirements if they initiate a transaction that offers fund investors the option between selling all or a portion of their interests in the private fund and converting or exchanging them for new interests in another vehicle advised by the adviser or any of its related persons (an “adviser-led secondary transaction”).
This rule will provide an important check against an adviser’s conflicts of interest in structuring and leading such a transaction from which it may stand to profit at the expense of private fund investors.

5. Restricted Activities

The new rule restricts advisers to a private fund from allocating certain expenses unless they satisfy certain disclosure and, in some cases, consent requirements. Examples of the affected activities include:
- Charging or allocating fees and expenses related to an investigation on account of violating the Investment Advisers Act of 1940;
- Charging the private fund for any regulatory, examination, or compliance fees or expenses of the adviser or its related persons; and
- Charging or allocating fees and expenses related to a portfolio investment on a non-pro rata basis when more than one private fund or other client advised by the adviser, or its related persons, have invested in the same portfolio company.

6. Documented Annual Compliance Review

SEC amended rule 206(4)-7 to require all registered investment advisors to document the results of an annual compliance assessment. The annual compliance assessment is expected to include testing activites that are designed to identify compliance risks.

Reminders:

Scope: The quarterly statement, audit, and adviser-led secondaries rules apply to all SEC-registered advisers, and the restricted activities and preferential treatment rules apply to all advisers to private funds, regardless of whether they are registered with the SEC.
New rule effective date:
- These final rules will be effective 60 days after publication in the Federal Register (“effective date”), while the effective date for quarterly statement and private fund audits will be 18 months after the effective date.
Quarterly statement deadline: If the private fund is not a fund of funds, then a quarterly statement must be distributed within 45 days after the end of each of the first three fiscal quarters of each fiscal year and 90 days after the end of each fiscal year. If the private fund is a fund of funds, then a quarterly statement must be distributed within 75 days after the first, second, and third fiscal quarter ends and 120 days after the end of the fiscal year of the private fund.