SEC Ushers in New Regulation for Private Fund Advisers

Wide-ranging reforms focused on transparency were adopted by the Securities and Exchange Commission (SEC) on August 23, 2023, to bring greater supervision to the private funds sector.

Investment advisers will need to understand the new requirements, which from a governance perspective represent the most significant regulatory change for investment funds in well over a decade.

After considerable uncertainty since the SEC’s original proposals emerged 18-months ago, the final rule has seen some of the more burdensome requirements diluted, however overall the reforms greatly expand the SEC’s oversight of advisers to private funds.

Increased Reporting and Disclosure Requirements

The new rules increase regulatory compliance obligations for all investment advisers to private funds. The compliance and reporting requirements are in some respects, now more onerous for advisers already registered under the Investment Advisers Act of 1940. Furthermore, certain rules will also apply to private fund advisers not required to be registered with the SEC.

In addition to new disclosure requirements, including information on preferential treatment to investors and conflicts of interest, the SEC has restricted some practices by advisers it says are potentially harmful to investors and run contrary to the public interest. These restricted activities are generally not-prohibited, providing appropriate disclosures are made and in some cases investor consent obtained.

All private fund advisers, however, are prohibited from providing investors with preferential treatment regarding redemptions and information if it would have a material, negative effect on other investors. A disclosure-based exception has been adopted for all other cases of preferential treatment, including disclosure of preferential terms to all current and prospective investors.

SEC registered investment advisors must comply with the following new rules:

Quarterly Statement Rule — Provide investors with quarterly statements detailing fund level information regarding performance, fees, expenses and compensation paid to the adviser.

Private Fund Audit Rule — Obtain and distribute to investors an annual financial statement audit of each private fund it advises, that meets the requirements of the audit provisions of the Advisers Act custody rule.

Adviser-Led Secondaries Rule — Provide a fairness or valuation opinion in connection with an adviser-led secondary transaction.

Compliance Rule Amendments — All registered investment advisers, including those that do not advise private funds, must document in writing an annual review of their compliance policies and procedures to help the SEC determine compliance and identify potential compliance weaknesses

All private fund advisers must comply with the following rules:

Restricted Activities Rule — Arising out of conflicts of interest, these activities are identified as contrary to the public interest and the protection of investors. All private fund advisers are restricted from engaging in:

• Charging or allocating fees or expenses associated with an investigation of the adviser to the private fund without disclosure and consent from investors. Fees or expenses related to an investigation that results in a sanction for violating the Advisers Act may not be charged.
• Charging or allocating regulator, examination or compliance fees or expenses without disclosure to investors.
• Reducing the amount of an adviser clawback for certain taxes, unless the pre-tax and post-tax clawback is disclosed to investors.
• Charging non-pro-rata fees or expenses related to a portfolio investment, unless the allocation approach is fair and equitable with advance written notice.
• Borrowing or receiving an extension of credit from a private fund client without disclosure to, and consent from, fund investors.

Preferential Treatment Rule — All private fund advisers from are prohibited from providing preferential terms regarding:

a) redemptions from the fund, unless the ability to redeem is required by law or the preferential redemption rights are offered to all other investors; and

b) information about portfolio holdings or exposures, unless such information is offered to all investors. All private fund advisers are prohibited from providing preferential treatment to investors, unless certain terms are disclosed in advance of an investment.

Legacy Status is provided by the SEC for activities prohibited by the Preferential Treatment Rule and aspects of the Restricted Activities Rule requiring investor consents. Legacy status provisions apply to governing agreements entered into prior to the compliance date if the applicable rule would require the parties to amend the agreements.

The Quarterly Statement Rule, Private Fund Audit Rule, Adviser-Led Secondaries Rule,

Restricted Activities Rule, and Preferential Treatment Rule do not apply to investment

advisers with respect to securitized asset funds.

Compliance Dates

The compliance date for the Private Fund Audit Rule and the Quarterly Statement Rule will be 18 months after the date of publication in the Federal Register.

The compliance date for the Adviser-Led Secondaries Rule, Preferential Treatment Rule, and

Restricted Activities Rule will be:

• 12 months after publication in the Federal Register for advisers with $1.5 billion or more in private funds assets under management.
• 18 months after publication in the Federal Register for advisers with less than $1.5 billion in private funds assets under management

Compliance with the Compliance Rule Amendment will be required 60 days after publication in the Federal Register.

Next Steps

With publication of the new rules and amendments in the Federal Register expected within the next 30 days, managers should advance steps with US counsel to identify the scope of their obligations. Calderwood’s team of independent directors possess expert knowledge of the regulatory and compliance environment for private funds in the Cayman Islands and the US and we would be pleased to be part of any discussions from a governance perspective.