On August 23, 2023, the SEC adopted numerous private fund reforms. Here’s a closer look at the new Preferential Treatment Rule and Legacy Status Rule.
The Preferential Treatment Rule (Rule 211(h)(2)-3)
The rule at a glance: The Preferential Treatment Rule creates new requirements for private fund advisers to disclose preferential terms (side letter terms) that have a material economic effect on investors before the fund accepts an investor’s commitments, and disclose all preferential terms after an investor invests. It also requires advisers to offer certain terms to all investors.
Who does it apply to? All private fund advisers (registered or not).
When the rule goes into effect: 12 months after publication in the Federal Register for advisers with $1.5 billion or more in private fund AUM, and 18 months after publication in the Federal Register for all other advisers — September 14, 2024, and March 14, 2025, respectively.
Why the reform matters: This rule creates substantially new disclosure requirements for all advisers. GPs will likely need to prepare disclosures before and after each close, as well as offer MFN elections to all investors if they offer preferential redemption or portfolio investment information terms to some investors.
What advisers need: GPs need an effective way to search, analyze, and disclose preferential terms to LPs before and after accepting investor commitments. They also need an efficient way to manage MFN elections. While firms have handled many of these issues with manual spreadsheets and PDFs in the past, they now face heightened scrutiny from the SEC. It’s time for a tech-enabled solution to support their fund and regulatory compliance efforts.
An in-depth look at the new rule: Private fund advisers may not provide certain types of preferential redemption terms to investors in a private fund or a similar pool of assets if the adviser reasonably expects the terms will have a material, negative effect on other investors in the private fund or similar pool of assets.*
- This restriction does not apply if the ability to redeem is required by applicable law or the adviser offers the preferential redemption rights to all other investors without qualification.
- Advisers are restricted from providing investors with preferential information rights about portfolio holdings or exposures, if the adviser reasonably expects that providing such information will have a material, negative effect on other investors in the private fund or similar pool of assets, unless such preferential information is offered to all investors at the same or substantially the same time.
- The rule prohibits all private fund advisers from providing preferential treatment to investors, unless the adviser discloses information regarding any preferential treatment related to any material economic terms provided to other investors in advance of a prospective investor’s investment in the private fund.
- Advisers must disclose all preferential treatment provided to investors in a written notice to current investors in the private fund after an illiquid fund’s fundraising period or the investor’s investment in a liquid fund, and on an annual basis thereafter.
- *A “similar pool of assets” is defined as a pooled investment vehicle (other than a registered investment company or business development company) with substantially similar investment policies, objectives, or strategies to those of the private fund managed by the adviser or its related persons.
How the final rule differs from the proposal: The final rule includes certain exceptions from the preferential redemptions and information prohibitions. It also limits the requirement to provide advance written notice of preferential treatment to only apply to material economic terms.
How Insight by Ontra can help advisers with their new compliance obligations
- Search documents: Analyze which terms are preferential in the private fund’s side letters and governing documents.
- Tag terms: Label preferential terms to easily identify, compare, and keep a digital record of them.
- Reference precedent: Search and review precedent to decide which terms to offer in negotiations and when to keep side letter language as consistent as possible across investors.
- Disclosures & MFN elections: Generate digital disclosures and MFN forms, capture elections, and track and comply with fund commitments.
The Legacy Status Rule
The rule at a glance: The SEC is providing legacy status for the prohibitions aspects of the Preferential Treatment Rule that require investor consent.
Why this rule matters: The rule “grandfathers” private fund governing documents that were already in place before the compliance date. This relieves advisers and their investors from having to renegotiate and amend pre-existing governing documents.
An in-depth look at the new rule: The Legacy Status Rule clarifies that portions of the Preferential Treatment Rule do not apply to contractual agreements advisers entered into in writing prior to the compliance date, which commenced operations as of the compliance date, if the restrictions would require the parties to amend the governing agreements of the private fund.
- The Legacy Status rule does not apply to private fund advisers’ requirement to provide written disclosures to investors regarding preferential treatment.
- Private fund governing agreements include the fund’s operating or organizational agreements, subscription agreements, and side letters.
- A private fund has commenced operations if it has engaged in bona fide investment, fundraising, or operational activity.
Key resources
Is your firm prepared?
The SEC’s private fund adviser reforms have raised the stakes for future SEC exams. You have until September 14, 2024, or March 14, 2025, depending on your private fund AUM, to implement best practices and adopt an efficient and tech-enabled system to support compliance with the new rules.
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 and regulatory obligations.
