The SEC Adopts Private Fund Adviser Rules – What Firms Should Know

On Wednesday, August 23, 2023 the U.S. Securities and Exchange Commission (SEC) voted 3-2 to adopt the Private Fund Adviser Rule (IA-5955), a series of rules and amendments (the Final Rules) under the Investment Advisers Act of 1940 (the Advisers Act) that will significantly impact the private funds industry. 

The Final Rules bring into being the new Advisers Act rules and amendments that were proposed in February 2022 (Proposed Rules).

The Proposed Rules had been under discussion between the SEC, private fund managers, and industry associations for the past 18 months, and experienced several changes during that time. The Final Rules reflect numerous instances in which the SEC revised and softened some of the stricter prohibitions in the Proposed Rules, but will nonetheless have significant and far reaching implications for private fund managers. 

Below is a summary of The Final Rules.

Quarterly Investor Reports

New rule 211(h)(1)-2 will require private fund advisers to provide investors with quarterly statements reflecting the fund’s fees, expenses, and performance, as well as any compensation paid by portfolio companies to the adviser or related persons. Reports must be clear and concise and include relevant disclosures to help ensure investors have a clear understanding of how the information presented was calculated. The quarterly reports must be designed to facilitate review from one quarter to the next. This rule will have an 18-month compliance period. Of all the newly adopted rules, this rule is likely to have the most significant ongoing implications for private fund managers given the depth of required reporting and the specifics around what is shown and how it must be calculated.  ACA is developing technology-enabled report preparation processes, as well as calculation and presentation frameworks, to help clients meet this rule’s requirements in ways that are consistent, efficient, and scalable.

Restricted Activities

New rule 211(h)(2)-1 restricts certain practices involving private funds unless the adviser provides disclosure to all investors, and in some cases, unless the adviser obtains affirmative consent. Covered practices include:

• the allocation of compliance fees and expenses, as well as expenses associated with government investigations, to a private fund;
• reductions in performance fee claw backs by taxes;
• non-pro-rata expense allocations; and
• borrowing from private funds.

The SEC included language that excludes funds with pre-existing arrangements that would need to be amended to comply with the new rule. Notably, the SEC omitted a provision prohibiting the collection of fees for services not performed, but included interpretive guidance in the adopting release indicating that such practices would be inconsistent with an adviser’s fiduciary duty. 

Adviser-Led Secondaries

For an adviser-led secondary transaction, new rule 211(h)(2)-2 requires an adviser to obtain and distribute a fairness opinion or valuation opinion from an independent provider, and to disclose in advance any material business relationship between the adviser and the independent provider. 

Preferential Treatment

New rule 211(h)(2)-3 limits the ability of advisers to offer preferential redemption or information rights that could have a material negative impact on other investors, unless those rights are offered to all investors. Redemption rights are allowed for investors who are required by law to have such rights, and pre-existing redemption and information rights may persist where a change would require a contractual amendment. In addition to significant restrictions on redemption and information rights, new rule 211(h)(2)-3 prohibits other kinds of preferential treatment unless advance and periodic notice is provided to investors.

Given the SEC’s focus on the disclosure and documentation of consents around preferential rights, advisers that are using email or manual tracking to manage side letters will benefit significantly by moving to more robust technology-driven solutions. ACA can tech-enable advisers with the management of side letters and the respective provisions through our Side Letter and Legal Document Management module in ComplianceAlpha^®.

Additional Considerations

For each of these four new rules, securitized asset funds were excluded from the rules’ scopes.

In addition to the four new rules noted above, the SEC:

• Amended the Compliance Program Rule to require that annual compliance program reviews be documented in writing.
• Required that all private funds managed by registered investment advisers must be audited, effectively eliminating the surprise asset verification option for private funds.
• Imposed new recordkeeping obligations related to the new rules.

Compliance dates vary, ranging from a 60-day compliance period for the requirement to document annual compliance program reviews, to a 12-to-18-month compliance period for most new requirements.

Our guidance

Private fund advisers are facing a dizzying array of new and proposed rules, all with compressed and overlapping time periods. 

The SEC’s recent vote to approve the Final Rules presents some of the most significant private funds regulatory reform since the Dodd Frank Act. Up next, they will turn to finalizing other new rules impacting private funds, including cyber, ESG, outsourcing, custody, and many more. Investment advisers are being challenged to comply with these new regulatory obligations while still working to implement the new Marketing Rule and Form PF amendments and navigate increased exam and enforcement scrutiny. 

The Final Rules will require massive implementation efforts, the implications of which private fund advisers should begin considering and planning for now. This will include undertaking readiness assessments and gap analyses and developing detailed project plans to manage all the changes and interdependencies. 

Given the heavy lift required for firms to prepare for and remain in compliance with the new rules, firms will likely need to leverage compliance consulting support, outsourced managed services, and regulatory technology and data analytics. 

Finally, the broad impact of these new rules will be felt across the business and will require close coordination across the firm, including the Management, Compliance, Finance, Technology and Operations. This is an unprecedented time of regulatory change and challenge for private funds and advisers.

How we help

Compliance teams need continuous support and knowledge sharing to stay on top of global regulatory initiatives. Our team helps you navigate the evolving regulatory landscape while considering the complexity of your firm’s unique compliance requirements.

We help our clients manage regulatory compliance and performance verification through our consulting, outsourcing, and technology solutions.

If you have any further questions about this alert, please reach out to your ACA consultant or contact our team here.

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