Home > Insights > Publications > SEC's Recent Rule Changes for Private Fund Advisers: What You Need to Know
On August 23, 2023, the Securities and Exchange Commission (the “SEC”) enacted new rules and amendments (the “Final Rules”) under the
Investment Advisers Act of 1940, as amended (the “Advisers Act”) which implicate the activities of private fund advisers (“PFAs”).
The Final Rules reflect a number of updates compared to the rules and amendments as originally proposed by the SEC on February 9, 2022.
The Final Rules require all investment advisers registered with the SEC, including registered PFAs (“Registered PFAs”), to document their annual review of compliance policies and procedures in
writing. Further, the Final Rules require Registered PFAs (a) to provide additional disclosure to private fund investors, (b) to cause their advised funds to complete an annual audit, and (c) to obtain a fairness or valuation opinion for secondary
transactions led by the Registered PFA. Finally, the Final Rules (i) require all PFAs, including those not registered with the SEC, to refrain from certain conflicted activities unless additional disclosure is provided to their investors and, in some
instances, investor consent is obtained and (ii) prohibit certain types of preferential treatment without disclosure to current and prospective investors.
All registered advisers, including Registered PFAs, will be subject to amended requirements under Rule 206(4)-7 of the Advisers Act (the “Compliance Rule”). Specifically, all advisers registered
with the SEC must amend their annual review procedures to require written documentation of their annual compliance review (the “Annual Review Rule”). The enactment of the Annual Review Rule
has the dual aim of assisting advisers in assessing whether they’ve met the requirements of the Compliance Rule and allowing the SEC to better determine whether a particular adviser is regularly reviewing its compliance policies and procedures.
As advisers registered with the SEC, all Registered PFAs will be required to comply with the Annual Review Rule.
NEW AND AMENDED REQUIREMENTS OF REGISTERED PRIVATE FUND ADVISERS
Certain of the Final Rules are only applicable to Registered PFAs. Registered PFAs are subject to the following set of new or amended requirements:
The Quarterly Statement Rule
The new Rule 211(h)(1)-2 of the Advisers Act requires Registered PFAs to distribute simple and clear quarterly statements to private fund investors which disclose the fees and expenses to be paid by private fund investors as well as the performance of
the private fund. Specifically, Rule 211(h)(1)-2 requires the delivery of a quarterly statement which includes (1) a tabular disclosure of fees paid to the Registered PFA or its related persons during that quarter, broken out with separate line items
based on the type of fee received, and (2) an additional table describing the applicable performance metrics of the fund, which depend on whether the fund in question is liquid or illiquid.
The SEC has placed specific emphasis on clarifying the underlying calculations of such fees as well as the fund’s performance. The SEC stated that this rule was enacted to combat fraud and deceptive practices, including certain behaviors and activities that have been the subject of recent enforcement actions cited by the SEC. [1]
The Audit Rule
The new Rule 206(4)-10 of the Advisers Act requires Registered PFAs to cause the private funds they advise, directly or indirectly, to undergo an annual financial statement audit compliant with the audit standards set forth in Rule 206(4)-2 under
the Advisers Act (the Custody Rule). This rule is meant to clarify and work toward standardizing the valuation process for funds advised by Registered PFAs.
The Adviser-led Secondaries Rule
The new Rule 211(h)(2)-2 of the Advisers Act requires Registered PFAs to provide investors with either a fairness opinion or a valuation opinion from a third party, along with a written summary of any material business relationship between the Registered
PFA and such third party opinion provider, if applicable. The Adviser-led Secondaries Rule applies when a Registered PFA initiates a transaction which offers fund investors the option between selling some or all of their interests in the private
fund and converting or exchanging such interests for new interests in another vehicle advised by the Registered PFA or any of its related persons.
The intent of the Adviser-led Secondaries Rule is to provide a check against conflicts of interest that arise when a Registered PFA structures and leads a transaction from which it may stand to profit at the expense of the private fund investors by
providing such investors more comprehensive disclosure of the nature of the proposed transaction.
The Recordkeeping Rule
The amended Rule 204-2 of the Advisers Act requires Registered PFAs to retain appropriate books and records related to the foregoing rules, along with the rules set forth below. Such retained records include (a) copies of quarterly statements as well
as the information relevant to the fees, expenses, and performance included in the quarterly statement; (b) copies of the audited financial statement prepared pursuant to the Audit Rule; (c) documents supporting a Registered PFA’s determination
of liquidity or illiquidity of an advised fund; and (d) copies of the fairness or valuation opinion related to an adviser-led secondary transaction.
The Recordkeeping Rule was enacted to enhance Registered Advisers’ internal compliance efforts and to improve the SEC’s ability to assess a Registered adviser’s compliance with the final rule.
NEW AND AMENDED REQUIREMENTS OF ALL PRIVATE FUND ADVISERS
Those Final Rules which prohibit certain activities are applicable to all PFAs, but do not extend to other advisers registered with the SEC. All PFAs (including those not registered with the SEC) are subject to the following set of new or amended requirements:
The Restricted Activities Rule
The new Rule 211(h)(2)-1 of the Advisers Act restricts all PFAs from engaging in the activities listed below without providing sufficient disclosure and, in certain cases, obtaining the consent of their investors:
- charging or allocating to the private fund fees or expenses associated with an investigation of the PFA or its related persons by any governmental or regulatory authority (though, notwithstanding any disclosure or purported investor consent, a Registered PFA may never charge or allocate fees and expenses related to such an investigation which results or has resulted in a court or governmental authority imposing a sanction for violating the Act or the rules promulgated thereunder;
- charging or allocating to the private fund any regulatory or compliance fees or expenses, or fees or expenses associated with an examination, of the PFA or its related persons;
- reducing the amount of an adviser clawback by actual, potential, or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders;
- charging or allocating fees and expenses related to a portfolio investment (or potential portfolio investment) on a non-pro rata basis when multiple private funds and other clients advised by the PFA or its related persons have invested (or propose to invest) in the same portfolio investment, where such non-pro-rata allocation is fair and equitable and disclosed to investors prior to such charge/allocation; and
- borrowing money, securities, or other private fund assets, or receiving a loan or an extension of credit, from a private fund client.
The SEC notes in the text accompanying the Final Rules that it views the above activities as involving conflicts of interest or compensation schemes which are contrary to public interest and the protection of investors. Notably, the SEC initially proposed the Restricted Activities Rule without any allowance for engaging in the activities upon providing sufficient disclosure or obtaining investor consent. However, the SEC was persuaded that investors who are provided with appropriate disclosure could potentially benefit from the activities when such activities are carried out in the best interest of the private fund.
Note that the SEC has provided legacy status for the aspects of the Restricted Activities Rule requiring Registered PFAs to obtain investor consent. The legacy status provisions apply to contractual agreements that (a) were entered into before the compliance date, (b) govern a private fund that has commenced operations as of the compliance date, and (c) would otherwise be required to be amended under the Final Rules.
The Preferential Treatment Rule
The new Rule 211(h)(2)-3 of the Advisers Act prohibits PFAs from granting preferential redemption rights or information if, in each instance, the adviser reasonably expects such preferential rights would have a material, negative effect on other investors. The language of Rule 211(h)(2)-3(1)(i) and (ii) provides carveouts for any “preferential treatment” either required by law or that an RFA has already offered, and will continue to offer, to all other existing investors. The Final Rules further provide that PFAs must disclose all other types of preferential treatment to the investors, (both comprehensive post-fundraise disclosures as well as annual disclosure for liquid private funds.
The SEC advised that its goal is for the Preferential Treatment Rule will help private fund investors better understand marketplace dynamics and potentially expedite the process for reviewing and negotiating PFA fees and private fund expenses.
Note that the SEC has also provided legacy status for the prohibitions aspect of the Preferential Treatment Rule. The legacy status provisions apply to contractual agreements as described above.
COMPLIANCE DATES
The compliance dates for each of the rules within the Final Rules vary, with certain dates depending on the amount of an adviser’s assets under management (“AUM”).
| Rule | Compliance Date |
|---|---|
| The Annual Review Rule | 60 days after publication in the Federal Register |
| Rule | Compliance Date |
|---|---|
| The Audit Rule | 18 months after the date of publication in the Federal Register |
| Quarterly Statement Rule | 18 months after the date of publication in the Federal Register |
| Adviser-Led Secondaries Rule | 12 months after the date of publication in the Federal Register (for advisers with $1.5 billion or more in private funds AUM) 18 months after the date of publication in the Federal Register (for advisers with less than $1.5 billion in private funds AUM) |
| Rule | Compliance Date |
|---|---|
| The Preferential Treatment Rule (Aspects Not Subject to Legacy Status) | 12 months after the date of publication in the Federal Register (for advisers with $1.5 billion or more in private funds AUM) |
| The Restricted Activities Rule (Aspects Not Subject to Legacy Status) | 12 months after the date of publication in the Federal Register (for advisers with $1.5 billion or more in private funds AUM) |
12 months after the date of publication in the Federal Register (for advisers with $1.5 billion or more in private funds AUM) |
ADDITIONAL RESOURCES
- SEC Fact Sheet: Fact Sheet 6383 (sec.gov)
- Final Rule Summary and Language: Final Rule: Private Fund Advisers (sec.gov)
- SEC Press Release 2023-155: SEC.gov | SEC Enhances the Regulation of Private Fund Advisers
[1] See, e.g., In the Matter of Sabra Capital Partners, LLC and Zvi Rhine, Investment Advisers Act Release No. 5594 (Sept. 25, 2020) (settled order) (alleging that, among other things, an investment adviser misrepresented the performance of a fund it advised in updates sent to the fund’s limited partners); In the Matter of Finser International Corporation and Andrew H. Jacobus, Investment Advisers Act Release No. 5593 (Sept. 24, 2020) (settled order) (alleging that, among other things, an investment adviser charged a fund it advised performance fees contrary to representations made in the fund’s private placement memorandum); In the Matter of Omar Zaki, Investment Advisers Act Release No. 5217 (Apr. 1, 2019) (settled order) (alleging that, among other things, an investment adviser repeatedly misled investors in a fund it advised about fund performance); In the Matter of Corinthian Capital Group, LLC, Peter B. Van Raalte, and David G. Tahan, Investment Advisers Act Release No. 5229 (May 6, 2019) (settled order) (alleging that, among other things, an investment adviser failed to apply a fee offset to a fund it advised and caused the same fund to overpay organizational expenses); In the Matter of Aisling Capital LLC, Investment Advisers Act Release No. 4951 (June 29, 2018) (settled order) (alleging an investment adviser ailed to apply a specified fee offset to a fund it advised contrary to the fund’s limited partnership agreement and private placement memorandum).
Matter of Omar Zaki, Investment Advisers Act Release No. 5217 (Apr. 1, 2019) (settled order) (alleging that, among other things, an investment adviser repeatedly misled investors in a fund it advised about fund performance); In the Matter of Corinthian Capital Group, LLC, Peter B. Van Raalte, and David G. Tahan, Investment Advisers Act Release No. 5229 (May 6, 2019) (settled order) (alleging that, among other things, an investment adviser failed to apply a fee offset to a fund it advised and caused the same fund to overpay organizational expenses); In the Matter of Aisling Capital LLC, Investment Advisers Act Release No. 4951 (June 29, 2018) (settled order) (alleging an investment adviser ailed to apply a specified fee offset to a fund it advised contrary to the fund’s limited partnership agreement and private placement memorandum).