August 25, 2023

Client Alert

On August 23, 2023, the U.S. Securities and Exchange Commission (SEC) adopted new rules and amendments under the U.S. Investment Advisers Act of 1940 (Advisers Act) to enhance the regulation of private fund advisers.[i]

Overview:

The new rules require private fund advisers registered with the SEC to:

• Provide investors with quarterly statements detailing information regarding private fund performance, fees, and expenses;
• Obtain an annual audit for each private fund; and
• Obtain a fairness opinion or valuation opinion in connection with an adviser-led secondary transaction.

The new rules require that all private fund advisers (whether or not registered):

• Prohibit engaging in certain activities and practices that are contrary to the public interest and the protection of investors unless they provide certain disclosures to investors, and in some cases, receive investor consent; and
• Prohibit providing certain types of preferential treatment that have a material negative effect on other investors and prohibit other types of preferential treatment unless disclosed to current and prospective investors.

Additionally, the amendments require all registered advisers, including those that do not advise private funds, to document in writing the annual review of their compliance policies and procedures.

Finally, the adopting release reflects that a number of provisions from the February 2022 rule proposal[ii] were omitted or significantly modified.

The SEC has adopted these new rules to address certain practices that may impose significant risks and harms on investors and private funds. Certain of the rules affect all Registered Private Fund Advisers, some affect all Private Fund Advisers, and some affect all Registered Investment Advisers, as outlined below. The new rules have differing compliance dates and certain ones are subject to legacy rules.

For Registered Private Fund Advisers:

Quarterly Statement Rule. The new rules require registered private fund advisers to distribute a quarterly statement to private fund investors. The statement must disclose 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 adviser.

Private Fund Audit Rule. The new rules require registered private fund advisers to cause the private funds they advise to undergo a financial statement audit that meets the requirements of the audit provision in the Advisers Act custody rule (rule 206(4)-2). These audits are intended to provide an important check on the adviser’s valuation of private fund assets and protect private fund investors against the misappropriation of fund assets.

Adviser-Led Secondaries Rule. The new rules require a registered private fund adviser to 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 adviser or any of its related persons. The rule also requires the adviser to prepare and distribute to the private fund’s investors a summary of any material business relationships the adviser has, or has had within the prior two years, with the independent opinion provider. This requirement is intended to provide a check against an adviser’s conflicts of interest in structuring and leading such transactions.

Books and Records Rule Amendments. As part of the new rules, the SEC also included amendments to the books and records rule under the Advisers Act for registered private fund advisers.

For All Private Fund Advisers:

Restricted Activities Rule. To address certain conflicts of interest that the SEC determined have the potential to lead to investor harm, a new rule restricts all private fund advisers (whether or not registered) from engaging in the following activities that the SEC has determined are 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. Further, an adviser may not charge fees or expenses related to an investigation that results or has resulted in a court or governmental authority imposing a sanction 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. To address the material, negative effects of specific types of preferential treatment on other investors, the new rules prohibit all private fund advisers from providing preferential terms to investors regarding: (a) 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 (b) certain preferential information about portfolio holdings or exposures, unless such preferential information is offered to all investors. In addition, this rule prohibits all private fund advisers 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.

Legacy Status. The SEC is providing legacy status for the prohibitions aspect of the Preferential Treatment Rule and the aspects of the Restricted Activities Rule that require investor consent. The legacy status provisions apply to governing agreements that were entered into prior to the compliance date if the applicable rule would require the parties to amend the agreements.

For All Registered Advisers:

Compliance Rule Amendments. The new rules include amendments to the compliance rule under the Advisers Act requiring all registered advisers, including those that do not advise private funds, to document in writing the required annual review of their compliance policies and procedures. Written documentation of the annual review is intended to help the SEC to determine advisers’ compliance with the rules and identify potential compliance program weaknesses.

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 they advise.

Compliance Dates Summary:

The new rules do not take effect immediately, to allow time for advisers to review their documents and practices and to establish compliance protocols. The Compliance Date for each new rule is set forth below.

For questions about the new Private Fund Adviser Rules, please contact Richard Madris (rmadris@stroock.com) or Brayton Dresser (bdresser@stroock.com).

Richard Madris is a Partner in Stroock’s Private Funds & Asset Management group; Brayton Dresser is Special Counsel, and Jonathan Labib and Tavy Wu are associates.

[i] SEC Release No. IA-6383 (August 23, 2023).

[ii] SEC Release No. IA-5955 (February 9, 2022).

• Private Funds and Asset Management

• New York