On August 23, 2023, the Securities and Exchange Commission (the “SEC”) adopted new rules and amendments under the Investment Advisers Act of 1940 (the “Advisers Act”) that impose significant new requirements on advisers to private funds, and in some cases by extension, to the private funds, themselves. The full text of the new rules can be found here. The SEC has stated that “the reforms are designed to protect those who directly or indirectly invest in private funds by increasing visibility into certain practices, establishing requirements to address practices that have the potential to lead to investor harm, and prohibiting or restricting adviser activity that is contrary to the public interest and the protection of investors.”
To whom do the new rules apply?
The new rules were made under the Advisers Act and apply to advisers of “private funds.” Private funds under the Advisers Act are issuers that would be an investment company under the Investment Company Act of 1940 (the “Investment Company Act”), but for exclusions provided under Sections 3(c)(1) or 3(c)(7) of that act. In general, Section 3(c)(1) provides an exemption under the Investment Company Act for funds with no more than 100 beneficial owners, while Section 3(c)(7) provides an exemption for funds that are limited to qualified purchasers. Private fund advisers generally provide investment advice to the private fund and make investments on behalf of the private fund. Certain of the new rules under the Advisers Act apply only to private fund advisers who are registered under the Advisers Act, while other rules apply to both registered private fund advisers and private fund advisers that are not required to be registered under the Advisers Act.
What are the new rules that apply only to registered private fund advisers?
Quarterly Statement Rule. Registered private fund advisers are required to distribute a quarterly statement to private fund investors that includes information regarding the performance of the private fund, costs associated with investing in the private fund, fees and expenses paid by the private fund, and certain adviser compensation information.
Private Fund Audit Rule. Registered private fund advisers are required to cause the private funds they advise to undergo an annual financial statement audit that complies with the audit provision in the current Advisers Act custody rule.
Adviser-Led Secondaries Rule. Registered private fund advisers will be required to obtain an independent fairness opinion or a valuation opinion when offering existing investors the option between (a) selling their private fund interests and (b) exchanging their current interests for interests in another investment vehicle advised by the private fund adviser or its affiliates. In addition, the private fund adviser must disclose any material business relationships it has with the provider of the independent opinion.
Books and Records Rule Amendments. The existing Advisers Act books and records rule has been amended to require registered private fund advisers to retain books and records related to the Quarterly Statement Rule, the Private Fund Audit Rule, the Adviser-Led Secondaries Rule, and the Preferential Treatment Rule (discussed below), to help the SEC ensure compliance with the new rules by private fund advisers.
Are there any new rules that apply to registered advisers, even if they do not advise private funds?
Compliance Rule Amendments. The new rules amend the existing Advisers Act compliance rule to require all registered advisers, including those that do not advise private funds, to have written documentation of the required annual review of their compliance policies and procedures.
What are the new rules that apply to both registered and unregistered private fund advisers?
Restricted Activities Rule. To address certain conflicts of interest, both registered and unregistered private fund advisers are restricted from engaging in the following activities:
- Charging or allocating to the private fund fees or expenses associated with an investigation of the private fund adviser unless disclosure is provided and consent from the private fund investors is received. In addition, regardless of disclosure or consent, private fund advisers are prohibited from charging fees or expenses related to an investigation that results or has resulted in sanctions from a court or governmental authority for a violation of the Advisers Act or any rules thereunder;
- Charging or allocating to the private fund regulatory, examination, or compliance fees or expenses of the adviser, unless investors have received full disclosure of such fees and expenses;
- Reducing the amount of a private fund adviser clawback by the amount of certain taxes, unless the pre-tax and post-tax amount of the clawback have been disclosed to investors;
- Charging or allocating fees or expenses related to a portfolio investment on a non-pro rata basis, unless the private fund adviser distributes advance written notice of the non-pro rata charge along with a demonstration that the allocation approach is fair and equitable under the circumstances; and
- Borrowing or receiving an extension of credit from a private fund client without disclosure to, and consent from, the other investors in the private fund.
Preferential Treatment Rule. Both registered and unregistered private fund advisers are prohibited from providing preferential terms to investors regarding: (a) certain redemptions from the private fund, unless such redemptions are required by applicable law or the preferential redemption rights are offered to all other investors without qualification; and (b) certain preferential information about portfolio holdings or exposures, unless such preferential information is offered to all investors. In addition, both registered and unregistered private fund advisers are prohibited from providing preferential treatment to investors, unless material economic terms (as opposed to all proposed investment terms) of such preferential treatment are disclosed in advance and all investment terms are then disclosed after the investor’s investment.
Legacy Status. For the prohibitions aspects of the Preferential Treatment Rule and the investor consent aspects of the Restricted Activities Rule, the SEC has “grandfathered” governing agreements that were entered into prior to the applicable compliance date with respect to private funds that had commenced as of such compliance date, such that if the applicable rule would require the parties to amend those agreements, such agreements do not need to be amended.
Are there any exceptions to the above new rules?
The Quarterly Statement Rule, Private Fund Audit Rule, Adviser-Led Secondaries Rule, Restricted Activities Rule, and Preferential Treatment Rule do not apply to investment advisers with respect to securitized asset funds advised by them.
What are the compliance dates for the new rules?
Compliance with the Private Fund Audit Rule and the Quarterly Statement Rule is required 18 months after the date of publication of the new rules in the Federal Register. Compliance with the Adviser-Led Secondaries Rule, the Preferential Treatment Rule, and the Restricted Activities Rule is required: (a) for advisers with $1.5 billion or more in private funds assets under management, 12 months after the date of publication of the new rules in the Federal Register; and (b) for advisers with less than $1.5 billion in private funds assets under management, 18 months after the date of publication of the new rules in the Federal Register. Compliance with the Compliance Rule Amendments will be required 60 days after publication of the new rules in the Federal Register.
If you have any questions or would like additional information, please contact the authors or your MMM attorney.
