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Private fund impact of SEC adoption of final rules on private fund adviser reforms

In Aug. 2023, the Securities and Exchange Commission (SEC) adopted new rules under the Investment Advisers Act of 1940 for private fund advisers, following a comment period on previously proposed new rules. These final rules excluded some of the more contested parts of the initial proposal. While enhanced compliance requirements place an additional burden on private funds advisers, the SEC deems these essential. SEC chairman Gary Gensler stated, “Private funds and their advisers play an important role in nearly every sector of the capital markets. By enhancing advisers’ transparency and integrity, we will help promote greater competition and thereby efficiency. Consistent with our mission and Congressional mandate, we advance today’s rules on behalf of all investors – big or small, institutional or retail, sophisticated or not.” Given the critical role that private funds play in shaping the financial markets and impacting individuals through both direct investments and indirect exposure, transparency, and timeliness of information is crucial.

The rules have three application tranches for advisers as noted below. Based on the facts and circumstances relating to each respective fund, there are some exceptions to the application which can be seen in the full text of the rule.

  • These rules do not apply to securitized asset funds (CLOs) or to offshore offerings.
  • Restricted activities rule - prohibited from engaging in certain activities that are contrary to the public interest and protection of investors unless certain disclosures or consent is obtained from investors.
  • Preferential treatment rule - prohibited from providing certain types of preferential treatment that may have a material negative effect on other investors. Some of the new prohibited items will be allowed for existing funds under the legacy status. This applies to governing agreements that were entered into prior to the compliance date.
  • These rules do not apply to securitized asset funds (CLOs) or to offshore offerings.
  • Quarterly statement rule: Provide quarterly statements to investors that include information on fund performance, fees and expenses. If the private fund is not a fund of funds, then statements must be distributed within 45 days after the end of each of the three quarters and within 90 days after the end of the fiscal year. If the private fund is a fund of funds, then statements must be distributed within 75 days after the three quarters of the year and within 120 days after the end of the fiscal year.
  • Private fund audit rule: Obtain an annual audit. For each private fund that is not a fund of fund, audited financial statements should be distributed to current investors within 120 days of the end of the fiscal year. For each private fund that is a fund of fund, audited financial statements should be distributed within 180 days of the end of the fiscal year.
  • Adviser-led secondaries rule: Obtain a fairness opinion or valuation opinion in connection with an adviser-led secondary transaction, such as offering investors the option to sell their interest or exchanging it for another investment vehicle.
  • Recordkeeping rule amendment: Follow enhanced books and records amendments that focus and promote internal and external monitoring of compliance.
  • Compliance rule amendment: the new rules require all registered advisers, including those who do not advise on private funds, to document in writing the annual review of their compliance policies and procedures.

While these rules are effective as of Nov. 13, 2023, there are certain parts that include a transition period. The audit rule and quarterly statement rule require adoption over an 18-month transition period for all private fund advisers by March 14, 2025. For other adviser-led secondaries rules, these are implemented over a transition period based on assets under management (AUM). Those advisers with $1.5 billion or more in AUM have a one-year transition period, with an effective date of Sept. 14, 2024. Those advisers with less than $1.5 billion in AUM have an 18-month transition period, with an effective date of March 14, 2025. Compliance with the amended Advisers Act compliance rule will be required within 60 days after publication in the Federal Register which occurred on Sept. 14, 2023.

The audit and quarterly statement rules may have the most significant impact on private fund advisers. In the past, certain advisers may have elected to undergo a surprise examination instead of an audit to fulfill the custody rule requirement. However, private fund advisers will not be able to rely on the surprise examination option to fulfill the audit requirement. Advisers need to ensure that with the new requirement that a qualified audit firm is being used and that appropriate independence rules are being followed in the event an audit firm is providing other non-attest services.

The implementation of the quarterly statement rule will also require that advisers evaluate their and their administrators’ current reporting process and systems to ensure capability to create appropriate reports for these more frequent communications. While some funds may currently produce quarterly or annual statements, this rule is specific as to what needs to be included in the statements. These include: 

  1. Fund level table to provide information about fees and expenses,  
  2. Portfolio investment level table showing the payments made by the manager and its related persons by portfolio investments 
  3. Fee and expense disclosure that will include disclosure of the calculation of all fees and expense listed as separate line items 
  4. Performance for liquid funds including annual net returns over the past 10 years (or since inception), average annual net total returns for 1-, 5- and 10-year periods and cumulative net total returns for the current fiscal year through quarter end 
  5. Performance for illiquid funds that includes inception-to-date gross and net IRR, gross and net MOIC, gross IRR and MOIC of realized and unrealized extracts of the portfolio and a statement of contributions and distributions. 

Initial work to compile this information for each investor may be a time-consuming process, so it is recommended that implementation be started as soon as possible.

While these new rules place additional requirements that advisers should being working through, it should be noted that there currently is a trade association lawsuit that was filed on Sept.1, 2023. This lawsuit was filed by six trade associations challenging the validity and enforceability of these rules. They felt that these rules exceeded the SEC’s statutory authority, did not follow the notice and comment requirements, and consider them a violation of the Administrative Procedure Act. The outcome of this lawsuit may impact these new requirements but based on the limited time to implement the rules, waiting for a resolution to the lawsuit would not be the most prudent.

These rules seek to provide investors with additional insight into fund performance and transparency to their activities. The SEC believes this will help educate investors, allowing greater understanding of their investments and promote greater confidence in the information being produced. Private fund advisers should consider these new rules and take the necessary steps to ensure their timely compliance.

For the full SEC release for these rules, please see full private fund adviser reform

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