On Wednesday, August 23, 2023, the U.S. Securities and Exchange Commission (SEC) voted 3-2 to adopt private fund reforms.
Below we lay out:
- Pertinent background
- The private fund adviser reforms
- Compliance dates
- Links to important resources
- Next steps
Background of SEC scrutiny
The SEC’s scrutiny of private funds and their advisers has increased over the past decade, and in 2022, the Commission proposed amendments to Form PF and the Investment Advisers Act of 1940. Ontra discussed the proposed amendments here, as well as the context surrounding the SEC’s focus on private fund advisers.
Given the importance of the SEC proposals and changes to the outsourcing and marketing rules, Ontra COO Ben Levi sat down with Norm Champ, the former deputy director of the SEC’s Office of Compliance, to discuss the rapidly evolving regulatory landscape.
Ultimately, the proposed amendments generated impassioned responses, including significant pushback and suggestions of future litigation.
UPDATE: A coalition made up of the Managed Funds Association, American Investment Council, National Venture Capital Association, National Association of Private Fund Managers, Alternative Investment Management Association, and Loan Syndications & Trading Association filed a lawsuit against the SEC on Friday, September 1 in the Fifth Circuit Court of Appeals. The National Association of Private Fund Managers was founded in Fort Worth, Texas, last year after the SEC first proposed amendments to the Investment Advisers Act, providing the coalition with jurisdiction in one of the U.S.’s most conservative courts.
The final rules are summarized below.
Private fund adviser reforms: final rules
For registered private fund advisers
Quarterly Statement Rule: Distribute quarterly statements to investors with detailed information regarding fund performance, the cost of investing, fees and expenses paid by the fund, and certain compensation and other amounts paid to the adviser.
Private Fund Audit Rule: Obtain an annual financial statement audit that meets the requirements of the audit provision in the Advisers Act Custody Rule (rule 206(4)-2)) for each private fund.
Adviser-Led Secondaries Rule: Obtain a fairness opinion or valuation opinion in connection with adviser-led secondary transactions. Distribute to fund investors a summary of any material business relationships the adviser has, or has had within the prior two years, with the independent opinion provider.
Books and Records Rule Amendments: Comply with relevant amendments to the Books and Records Rule related to the above.
For all private fund advisers
Restricted Activities Rule: Private fund advisers may not engage in certain activities that are contrary to the public interest and the protection of investors unless they provide certain disclosures to investors and, in some cases, receive investor consent. These activities include, but are not limited to:
- Charging or allocating to the private fund fees or expenses associated with an investigation of the adviser without disclosure and consent from fund investors.
- Charging or allocating fees or expenses related to an investigation that results or has resulted in a court or governmental authority imposing a sanction for a violation of the Advisers Act or the rules thereunder.
- Charging or allocating to the private fund regulatory, examination, or compliance fees or expenses of the adviser, unless such fees and expenses are disclosed to investors.
- Reducing the amount of an adviser clawback by the amount of certain taxes, unless the adviser discloses the pre-tax and post-tax amount of the clawback to investors.
- Charging or allocating fees or expenses related to a portfolio investment on a non-pro rata basis, unless the allocation approach is fair and equitable and the adviser distributes advance written notice of the non-pro rata charge and a description of how the allocation approach is fair and equitable under the circumstances.
- Borrowing or receiving an extension of credit from a private fund client without disclosure to, and consent from, fund investors.
Preferential Treatment Rule: Private fund advisers may not provide certain types of preferential treatment to investors, which the SEC deems to have material negative effects, regarding:
- Certain redemptions from the fund, unless the ability to redeem is required by applicable law or the adviser offers the preferential redemption rights to all other investors without qualification.
- Certain preferential information about portfolio holdings or exposures, unless such preferential information is offered to all investors.
- In addition, the rule prohibits all private fund advisers from providing preferential treatment to investors unless certain terms are disclosed in advance of an investor’s investment in the private fund, and all terms are disclosed after the investor’s investment.
Legacy Status: Crucially, the SEC is providing legacy status for the prohibitions aspects of the Preferential Treatment Rule and Restricted Activities Rule that require investor consent. These provisions apply to governing agreements entered into prior to the compliance date of the rules if the applicable rule would require the parties to amend the agreements.
For all registered advisers
Amendments to Compliance Rule: Document in writing the required annual review of the registered adviser’s compliance policies and procedures (even for advisers that do not advise private funds).
Compliance dates
60 days after publication in the Federal Register — Amended Compliance Rule
12 months after publication in the Federal Register — The Adviser-Led Secondaries Rule, the Preferential Treatment Rule, and the Restricted Activities Rule for advisers with $1.5 billion or more in private funds AUM
18 months after publication in the Federal Register — The Private Fund Audit Rule and the Quarterly Statement Rule
18 months after publication in the Federal Register — The Adviser-Led Secondaries Rule, the Preferential Treatment Rule, and the Restricted Activities Rule for advisers with less than $1.5 billion in private funds AUM
UPDATE: The new private fund adviser rules were published in the Federal Register on September 14, 2023. The 12- and 18-month compliance dates will be September 14, 2024, and March 14, 2025, respectively.
Key resources
- Press Release, SEC Enhances the Regulation of Private Fund Advisers
- The Final Rule
- SEC Fact Sheet
- Chair Gary Gensler’s Statement on Private Fund Advisers
- Commissioner Jaime Lizárraga’s Statement, Empowering and Protecting Private Fund Investors
- Commissioner Mark T. Uyeda’s Statement on Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews
- Commissioner Caroline A. Crenshaw’s Statement Regarding Private Fund Advisers Rulemaking
- Commissioner Hester M. Peirce’s Statement, Uprooted: Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews
Next steps
The SEC’s new rules drastically affect how private funds navigate contract negotiations, investor obligations, and regulatory compliance. To adjust, it helps to have an obligation management solution like Insight to effectively monitor compliance and prepare for SEC exams.
Private fund advisers that rely on massive spreadsheets and reactive processes may feel stretched thin when adjusting to the new rules. Legacy tools and processes tend to be slow and require professionals to manually search for answers to questions and monitor compliance. Private fund professionals are better off with immediate access to their private fund documents and investor side letters with Insight. Old-school compendia won’t cut it.
Stay tuned
Stay tuned for more in-depth information on the new SEC rules and how Insight, Ontra’s AI-backed obligation management platform, can help private fund managers comply with investor obligations and SEC regulations.
