(Article from Registered Funds Regulatory Update, October 2023)
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In a recent 3-2 vote, the SEC adopted new and amended Private Fund Adviser Rules that will substantially increase the regulation of investment advisers to private funds. The Private Fund Adviser Rules generally focus on disclosure and reporting obligations and impose restrictions and disclosure requirements with respect to certain activities instead of outright prohibitions on such activities. The Private Fund Adviser Rules apply to investment advisers to private funds, which are defined as funds that would be investment companies but for the exclusion from the definition of investment company in Section 3(c)(1) or 3(c) (7) of the Investment Company Act, except the Private Fund Adviser Rules do not apply with respect to advisers to securitized asset funds that they advise (which includes CLOs, among other funds). Certain of the new provisions apply only to investment advisers that are registered or required to be registered with the SEC, whereas other provisions apply to all private fund investment advisers, whether SEC-registered, state-registered, un-registered, or “exempt reporting advisers” under the Advisers Act.
Reporting Obligations. Under the new Private Fund Adviser Rules, registered investment advisers to private funds must:
- Provide investors with quarterly statements detailing information regarding private fund performance as well as fees and expenses.
- Obtain an annual audit for each private fund.
- Obtain a fairness opinion or valuation opinion in connection with an adviser- or general partner-led secondary transaction.
Restricted Activities. Under the new Private Fund Adviser Rules, registered investment advisers and exempt reporting advisers are restricted from the following activities subject to consent-based and/or disclosure-based exceptions:
- Advisers are prohibited from charging or allocating to the private fund regulatory, examination, or compliance fees or expenses of the adviser, unless such fees and expenses (including the dollar amounts thereof) are disclosed to investors.
- Advisers must disclose and obtain consent from fund investors if the adviser charges or allocates to the private fund any fees or expenses associated with an investigation of the adviser; however, an adviser may not charge fees or expenses related to an investigation that results in a court or governmental authority imposing a sanction for a violation of the Advisers Act or the rules thereunder.
- Advisers are restricted from reducing the amount of an adviser (or affiliate) clawback by the amount of certain taxes unless the post-tax clawback is subject to after-the-fact disclosure.
- An adviser is prohibited from 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 it or its related persons have invested (or propose to invest) in the same portfolio investment unless (i) the allocation approach is fair and equitable, and (ii) the adviser distributes to fund investors advance written notice of the non-pro rata charge and a description of how the allocation approach is fair and equitable under the circumstances.
- Advisers are prohibited from borrowing or receiving an extension of credit from a private fund client without disclosure to, and consent from, fund investors.
Restrictions on Preferential Treatment of Certain Investors. The Private Fund Adviser Rules generally:
- Prohibit registered investment advisers and exempt reporting advisers from providing preferential liquidity (i.e., redemption rights) or informational rights that the adviser reasonably expects to have a material negative effect on fund investors, unless this treatment is offered to other investors in the private fund and any similar pool of assets.
- Prohibit registered investment advisers and exempt reporting advisers from providing other types of preferential treatment, unless preferential material economic terms are disclosed in advance of an investor’s investment in the private fund and all preferential terms are disclosed after the investor’s investment.
- Require the registered investment adviser and exempt reporting adviser to distribute to prospective investors, prior to an investor’s investment in the fund, and to current investors a written notice of all preferential treatment the adviser or its related persons has provided to other investors in the same private fund.
Amendment to Advisers Act Books and Records and Compliance Rules. The SEC also amended the Advisers Act books and records rule to require registered investment advisers to retain specified materials related to the new Private Fund Adviser Rules and amended the Advisers Act compliance rule to require all registered investment advisers to document in writing their annual review of their compliance policies and procedures. The amendment to the compliance rule does not mandate a particular form or format for the adviser’s documentation of its compliance policies and procedures, and as noted in the adopting release, many advisers already document, in some manner, their reviews of their compliance policies and procedures. Significantly, this amendment applies to all registered investment advisers, including those that do not advise private funds, and has the earliest compliance date of all the requirements adopted in this rulemaking—60 days after the Private Fund Adviser Rules are published in the Federal Register. Other requirements set forth in the Private Fund Adviser Rules have varying compliance periods following publication in the Federal Register.
Private Fund Advisers; Documentation of Registered Investment Adviser Compliance, SEC Rel. No. IA-6383 (Aug. 23, 2023), available at: https://www.sec.gov/files/rules/final/2023/ia-6383.pdf.