On August 23, 2023, the Securities and Exchange Commission (the “SEC”) voted 3-2 (with Commissioners Peirce and Uyeda dissenting) to adopt the final version of its highly anticipated Private Funds Rules (hereinafter referred to as the “Adopted Private Funds Rules”) under the Investment Advisers Act of 1940 (the “Advisers Act”).
After a period of sustained industry pressure and an active public commentary period, the SEC scaled back the Adopted Private Funds Rules from its February 2022 proposal in certain important respects (e.g., by jettisoning its proposal to prohibit private fund advisers from limiting their liability for negligence). However, the Adopted Private Funds Rules still impose substantial new disclosure and other requirements on not only SEC-registered investment advisers, but on all private fund advisers (regardless of registration status) as summarized below.
Overall, the Adopted Private Funds Rules represent a significant expansion of the SEC’s regulation of the private funds industry. Please note that this alert highlights key aspects of the Adopted Private Funds Rules but does not discuss every aspect of them.
For All Investment Advisers (whether or not registered with the SEC):
The SEC’s initial rule proposal contemplated flatly prohibiting certain activities by all advisers, but the Adopted Private Funds Rules permit such activities with investor notice or consent as noted below.
- Investigation Expenses. Advisers must now obtain the written consent from at least a majority in interest of investors in order to charge or allocate to a private fund any fees or expenses incurred in connection with the investigation of an adviser. Note, however, that advisers will be flatly prohibited from charging any fees or expenses related to an investigation that results in the imposition of a sanction for a violation of the Advisers Act.
- Regulatory, Compliance, and Exam Expenses. Advisers must now provide investors with written notice of any fees and expenses in respect of an adviser’s regulatory, examination, or compliance activities, including the dollar amounts thereof, to investors within 45 days of the end of the fiscal quarter in which the charge occurs.
- Reducing Adviser Clawback for Taxes. Advisers must now provide written notice to investors that discloses the pre- and post-tax amount of the clawback within 45 days of the end of the fiscal quarter in which the clawback occurs prior to reducing its clawback obligation by the amount of actual, potential, or hypothetical taxes applicable to the adviser, its related person(s), or their respective owners.
- Borrowing. Advisers must now provide written notice setting forth the material terms of any borrowing or extension of credit from a private fund client and obtain written consent from at least a majority in interest of investors in the private fund.
- Non-Pro Rata Expense Allocation. Advisers are now restricted from charging or allocating fees or expenses related to a portfolio investment on a non-pro rata basis, unless such allocation approach is fair and equitable under the circumstances and the adviser provides advance written notice to investors describing the non-pro rata charge and setting forth why it is fair and equitable under the circumstances.
New restrictions on providing certain types of preferential treatment related to redemptions and information rights (e.g., through the grant of such rights via side letters) and additional requirements for increased transparency on other types of preferential treatment; specifically, the Adopted Private Funds Rules bar:
- the grant of preferential redemption rights that the adviser reasonably expects to have a material negative effect on other investors, unless such ability to redeem is mandated by applicable law applicable to an investor or the adviser otherwise offers such rights to all investors in the private fund;
- the provision of preferential information rights regarding portfolio holdings or exposure that the adviser reasonably expects to have a material negative effect on other investors, unless such preferential rights are offered to all other investors in the private fund; and
- the provision of other preferential treatment, unless material economic terms are disclosed in advance of an investor’s investment in the private fund and all terms are disclosed following such investor’s investment.
In another departure from the proposed rules, the SEC has included a grandfathering provision in the Adopted Private Funds Rules that, subject to certain exceptions, covers agreements entered into prior to the applicable compliance date described below, such that advisers will not have to re-write their existing contractual agreements with investors as a general matter.
For SEC-Registered Investment Advisers:
The Adopted Private Funds Rules require SEC-registered advisers to:
- Prepare and distribute quarterly statements to investors that disclose fund performance, fees and expenses paid during such period, and compensation paid to the adviser and/or its related persons by a private fund’s portfolio investments;
- Obtain an annual audit by an independent public accountant for each provide fund managed by it that complies with the current Custody Rule’s audit provision;
- Provide investors with a fairness opinion or a valuation opinion in the context of adviser-led secondary transactions as well as a summary of material business relationships between the adviser and/or any of its related persons with such opinion or valuation provider, if any; and
- Document the annual compliance review in writing.
When will the Adopted Private Funds Rules take effect?
There are staggered compliance dates for different portions the Adopted Private Funds Rules:
- For the new rules regarding restricted activities, preferential treatment, and adviser-led secondaries, the compliance date will be (i) 18 months after the publication date in the Federal Register (i.e., the summer of 2025) for advisers with less than $1.5B in private fund assets and (ii) 12 months after such publication date (i.e., late 2024) for advisers with more than $1.5B in private fund assets;
- For the new audit and quarterly statement rules, the compliance date will be 18 months from the publication date.
Note that the Adopted Private Funds Rules are scheduled to be published within 60 days of August 23, 2023.
For further information, contact your Croke Fairchild lawyer or: