As noted in our prior alert “The SEC’s New Private Funds Rule,” the Securities and Exchange Commission (the “SEC”) voted on August 23, 2023 to adopt the final version of its highly anticipated Private Funds Rules (hereinafter referred to as the “Rules”) under the Investment Advisers Act of 1940.
The Rules — which are expected to become effective in late 2024 for advisers with more than $1.5B in private fund assets, and in mid-2025 for advisers with less than $1.5B in private fund assets¹ — impose substantial new disclosure and other requirements on all private fund advisers, including exempt reporting advisers.
So what can advisers do to prepare to comply with the Rules in advance of those dates?
For All Investment Advisers, Including Exempt Reporting Advisers:
- Borrowing. Advisers should prepare policies and procedures around borrowings or extensions of credit from any of their private fund clients. Specifically, the adviser 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 with respect to any such borrowing.
- Preferential Treatment. The Rules impose new restrictions on providing certain types of preferential treatment related to redemptions, information rights and economic terms (e.g., through the grant of such rights via side letters). Additional requirements for increased transparency on other types of preferential treatment do not allow certain preferential rights unless offered to all investors. In light of these requirements, certain advisers may seek to avoid entering into side letters as a matter of policy and instead specify certain preferential terms that may potentially be available to investors in the governing documents of the private fund, so that all investors are privy to them from the outset. For instance, an adviser may decide to offer fee breaks to certain investors that have made commitments to the fund in excess of a particular threshold. To the extent that the adviser details that threshold and related discount(s) in the fund’s governing agreement, it would not be required to offer other investors the opportunity to elect such a provision.
- Grandfathering. The SEC has included a grandfathering provision in the Rules that, subject to certain exceptions, applies to agreements entered into prior to the applicable compliance dates described above, such that advisers will not have to re-write their existing contractual agreements with investors, except in certain limited circumstances². The grandfathering provision in the Rules pertains only to specific features of the preferential treatment rule and the restricted activities rule as applied to existing funds, so an adviser will need to consider the impact the Rules may have on other aspects of its management of its existing private funds as well as any new funds that it intends to establish.
For SEC-Registered Investment Advisers:
- Compliance Review Process. All SEC-registered investment advisers are required to review and create a written documentation of, not less frequently than annually, the adequacy of the adviser’s policies and procedures and the effectiveness of their implementation. The Rules do not detail the manner or format of such documentation; an adviser could aggregate documentation from reviews performed on a quarterly basis, incorporate a presentation to a board or LPAC, or include a short memorandum summarizing the findings of such review.
Please note that this alert is intended to offer some suggestions for ways advisers may consider preparing themselves for compliance with the Rules, both as a direct result of the Rules’ requirements or as an industry best-practice, but it does not cover all aspects of the Rules that are applicable to advisers. Additionally, we expect to receive further SEC and industry guidance during the implementation period, which will help inform and refine our suggested strategies. We will be reaching out with supplemental information as it becomes available and are always available to discuss any questions specific to your firm as they arise.
For more information, please contact your CFDB lawyer or: