SEC Adopts Final Rules on Private Fund Adviser Reforms

On August 23, 2023, the U.S. Securities and Exchange Commission (the “SEC”) adopted highly anticipated new rules and amendments (the “Final Rules”) under the Investment Advisers Act of 1940 (the “Advisers Act”) in an effort to enhance the SEC’s regulation of private fund advisers and level the playing field among investors in private funds, thereby increasing the compliance burdens for private fund advisers. Certain Final Rules apply to all private fund advisers regardless of SEC registration status, while other provisions of the Final Rules apply only to SEC-registered private fund advisers. The Compliance Rule amendment applies to all SEC-registered advisers, regardless of whether they advise private funds.

For all private fund advisers (regardless of SEC registration status), the Final Rules:

  • Restrict a private fund adviser from (the “Restricted Activities Rule”):
    • charging or allocating to an advised private fund: portfolio investment expenses on a non-pro rata basis with other funds or clients, or regulatory/compliance/examination expenses, in each case without providing certain disclosures to investors;
    • reducing the amount of the adviser clawbacks by actual/potential/hypothetical taxes, without providing certain disclosures to investors;
    • borrowing from an advised private fund, without obtaining investor consent; and
    • charging or allocating to an advised private fund certain expenses associated with a regulatory investigation of the adviser or its related persons, without obtaining investor consent,
      • with the caveat that, in the event that such investigation results in a sanction for a violation of the Advisers Act or rules thereunder, charging or allocating associated expenses to the advised private fund is prohibited.
  • Prohibit a private fund adviser from (the “Preferential Treatment Rule”):
    • granting two types of preferential terms to select investors that the adviser reasonably expects to have a material negative effect on other investors: (i) preferential redemption rights, unless required by applicable law or offered to all investors, and (ii) enhanced portfolio holding/exposure information, unless offered to all investors; and
    • granting preferential treatment terms to select investors unless all such preferential treatment terms are disclosed to current investors, and all preferential material economic terms are disclosed to prospective investors.

Under the Final Rules, all SEC-registered private fund advisers are required to:

  • Provide investors with quarterly statements detailing information regarding private fund performance, fees, and expenses (the “Quarterly Statement Rule”);
  • Cause advised private funds to undergo an annual financial statement audit that meets the requirements of the audit provision in the Advisers Act Custody Rule (for a private fund with which the adviser is not in a control relationship, such as a sub-advised fund, the adviser must take all reasonable steps to cause the fund to undergo such audit) (the “Private Fund Audit Rule”);
  • Obtain a fairness opinion or valuation opinion in connection with an adviser-led secondary transaction (the “Adviser-Led Secondaries Rule”); and
  • Prepare and retain records relating to compliance with the Final Rules (the “Recordkeeping Rule amendment”).

Under the Final Rules, all SEC-registered advisers (regardless of whether they advise private funds) are required to:

  • document in writing the required annual review of their compliance policies and procedures (the “Compliance Rule amendment”).

The compliance dates of the Final Rules vary as follows:

  • the Quarterly Statement Rule and the Private Fund Audit Rule have an 18-month transition period;
  • the Restricted Activities Rule, the Preferential Treatment Rule and the Adviser-Led Secondaries Rule:
    • 18-month transition period for smaller private fund advisers (those with less than $1.5 billion in private funds assets under management);
    • 12-month transition period for larger private fund advisers;
  • the Recordkeeping Rule amendment:
    • 18-month transition period for smaller private fund advisers;
    • 12- or 18- month transition period for larger private fund advisers, in conjunction with the underlying Final Rules; and
  • the Compliance Rule amendment: 60 days.

All the above compliance deadlines run from publication of the Final Rules in the Federal Register. Historically, publication of a significant rule has occurred 30 or more days after adoption. In addition, the SEC granted legacy relief (i.e., grandfathering) to the below provisions under the Restricted Activities Rule and the Preferential Treatment Rule, with respect to (i) existing contractual agreements that were entered into prior to the applicable compliance date and (ii) agreements governing private funds that had commenced operations as of the compliance date, in each case if the rule would require the parties to amend such agreements.

  • With regard to the Restricted Activities Rule:
    • The SEC granted legacy relief only for those restricted activities that require investor consent (i.e., charging/allocating expenses associated with certain regulatory investigations to an advised private fund and borrowing from an advised private fund), but elected not to extend such legacy relief for restricted activities that are prohibited or subject to prior or post investor notices (charging non-pro rata portfolio investment expenses and regulatory/compliance/examination expenses, reducing adviser clawbacks for taxes, charging expenses associated with a regulatory investigation for Advisers Act violations).
    • The SEC reasoned that disclosure of information is not sufficiently burdensome or disruptive to warrant legacy treatment. As a result, prior to the applicable compliance dates, private fund advisers should consider reviewing their existing fund documents and/or contractual agreements containing those non-grandfathered restricted activities.
  • With regard to the Preferential Treatment Rule:
    • The SEC granted legacy relief only for those prohibitions relating to redemption rights and portfolio holdings information, but did not extend such legacy relief for (i) any other preferential treatment terms (e.g., fee breaks, opt-out rights) or (ii) disclosure requirements associated with all preferential treatment.
    • The SEC noted in the Final Rules release that private fund advisers must disclose to investors in a private fund post-compliance date, any preferential treatment terms that existed before the compliance date (although identity of a specific investor may be anonymized or redacted).
    • These post-compliance period disclosure requirements are likely to impact not only private fund advisers but also investors as investors may not want certain preferential terms specific to their business practices to be disclosed to all other investors.

The Final Rules have some additional noteworthy takeaways:

  1. The SEC did not adopt their previously proposed standard of care rule, which would have prohibited private fund advisers from limiting their liability or seeking indemnification from their advised private funds, for negligence, willful misfeasance, bad faith, recklessness, or a breach of fiduciary duty. However, the SEC reiterated the advisers’ non-waivable federal fiduciary duty and the Advisers Act’s antifraud provisions in discussing the interplay between such provisions and these standards. In fact, in recent examinations, the SEC has focused on improper “hedge clauses.”
  2. The Quarterly Statement Rule for SEC-registered private fund advisers is quite extensive and onerous and may complicate private fund advisers’ compliance with the Marketing Rule.
  3. The SEC relaxed its proposal with respect to prohibiting after-tax clawbacks, opting instead for disclosure rather than an outright prohibition.
  4. The prohibition on granting preferential liquidity and enhanced portfolio information requires a subjective determination by a private fund adviser regarding the “material, negative effect on other investors” qualifier.
  5. The SEC did not adopt its previously proposed rule prohibiting a private fund adviser from charging a portfolio investment for fees in respect of any services that the investment adviser does not, or does not reasonably expect to, provide to the portfolio investment. Nevertheless, the SEC indicated that such activity already is inconsistent with the adviser’s fiduciary duty.
  6. The Final Rules will not apply to non-U.S. advisers (registered or unregistered) with respect to their advised non-U.S. private funds (regardless of whether those funds have U.S. investors), and all the new rules will not apply to private fund advisers with respect to their advised securitized asset funds (“SAFs”) (such as collateralized loan obligations), but do apply to their advised credit funds, hedge funds, private equity funds, venture capital funds, real estate funds, and other non-SAF private funds.

The 660-page Final Rules release leaves a great deal to digest, and the SEC staff will undoubtedly issue FAQ guidance in the months to come. To familiarize private fund advisers with the Final Rules, here is a table summarizing key points and compliance date of each Final Rule with its respective full text.

For more information on the Final Rules, please reach out to an attorney in the Investment Management practice of Tannenbaum Helpern Syracuse & Hirschtritt LLP.

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08.29.2023  |  PUBLICATION: BulletPoint  | 

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