SEC Issues New Impactful Restrictions and Disclosure Requirements on Private Fund Advisers
New Rules Will Reshape How Hedge Fund and Private Equity Fund Managers Raise Capital and Interact with Their Investors
Fort Lauderdale, Fla. (August 28, 2023) – On August 23, 2023, the Securities and Exchange Commission (SEC) voted 3-2 to adopt significant changes under the Investment Advisers Act of 1940 (Advisers Act) aimed at enhancing the regulation of private fund advisers including, in some instances, those that are not registered with the SEC. These new rules and amendments will, among other things, have an important impact on how private fund advisers report performance information to investors and utilize side letters to negotiate and attract investment.
Requirements for Registered Private Fund Advisers
Under the new rules and amendments, private fund advisers registered with the SEC (Registered Advisers) will be required to comply with the following:
- Quarterly Statement Rule: Registered Advisers must distribute a quarterly statement to private fund investors disclosing fund-level information regarding performance, the cost of investing in the private fund, fees and expenses paid by the private fund, as well as certain compensation and other amounts paid to the Registered Adviser.
- Private Fund Audit Rule: Registered Advisers must obtain annual audited financial statements for each private fund under advisement.
- Adviser-Led Secondaries Rule: Registered Advisers must obtain a fairness opinion or a valuation opinion when offering existing fund investors the option between selling their interests in a private fund and converting or exchanging their interests in the private fund for interests in another vehicle advised by the Registered Adviser or any of its related persons. The Registered Adviser must also prepare and distribute to the private fund’s investors a summary of any material business relationships the Registered Adviser has or has had within the prior two years with the independent opinion provider.
- Books and Records Rule Amendments: The amendments also provide for certain changes to the books and records rule under the Advisers Act for Registered Advisers.
Restrictions on all Private Fund Advisers
Restricted Activities Rule: All private fund advisers (including those not registered with the SEC) are restricted from engaging in the following activities that are deemed contrary to the public interest and the protection of investors:
- Charging or allocating to the private fund fees or expenses associated with an investigation of the adviser without disclosure and consent from fund investors;
- Charging fees or expenses related to an investigation that results or has resulted in a court or governmental authority imposing a sanction on the adviser for a violation of the Advisers Act or the rules promulgated thereunder;
- Charging or allocating to the private fund regulatory, examination, or compliance fees or expenses of the adviser, unless such fees and expenses are disclosed to investors;
- Reducing the amount of an adviser clawback by the amount of certain taxes, unless the adviser discloses the pre-tax and post-tax amount of the clawback to investors;
- Charging or allocating fees or expenses related to a portfolio investment on a non-pro rata basis, unless the allocation approach is fair and equitable and the adviser distributes advance written notice of the non-pro rata charge and a description of how the allocation approach is fair and equitable under the circumstances; and
- Borrowing or receiving an extension of credit from a private fund client without disclosure to, and consent from, fund investors.
Preferential Treatment Rule: Private fund advisers are prohibited from providing preferential terms to investors regarding:
- Certain redemptions from the fund, unless the ability to redeem is required by applicable law or the adviser offers the preferential redemption rights to all other investors without qualification; and
- Certain preferential information about portfolio holdings or exposures, unless such preferential information is offered to all investors.
- Private fund advisers are prohibited from providing preferential treatment to investors, unless certain terms are disclosed in advance of an investor’s investment in the private fund and all terms are disclosed after the investor’s investment.
Requirements for all Registered Investment Advisers
- Compliance Rule Amendments: All advisers registered with the SEC (including those that do not advise private funds) must document, in writing, the required annual review of their compliance policies and procedures.
- The Restricted Activities Rule and the Preferential Treatment Rule will apply to all private fund advisers, including those that are not registered with the SEC or with the States and that do not make filings with either the SEC or States. This includes foreign private advisers, advisers that are entirely unregistered, and advisers that rely on the intrastate exemption from SEC registration and/or the de minimis exemption from SEC registration.
- The Quarterly Statement, Restricted Activities, Adviser-Led Secondaries, Preferential Treatment, and Audit Rules do not apply to investment advisers with respect to any securitized asset funds (SAFs) under advisement.
We would be happy to assist should you have any questions regarding how these new rules and amendments may impact your fund operations. Visit our SEC Enforcement & Litigation Practice page to learn more about our capabilities in this area.
Dale Bergman, Partner
Andrew Zuckerman, Attorney