The Securities and Exchange Commission on Aug. 23, 2023, adopted new rules that increase the regulation of private funds.
Under the rules, registered private fund advisers must provide investors with quarterly statements that detail information about fund performance, fees and expenses. These requirements are intended to increase transparency.
The advisers must also get an annual audit for each private fund. This requirement will need to meet the requirements in the audit provision in Rule 206(4)-2 of the Investment Advisers Act of 1940, which is also known as the custody rule.
“These audits will provide an important check on the adviser’s valuation of private fund assets and protect private fund investors against the misappropriation of fund assets,” the SEC stated.
Moreover, registered private fund advisers must get 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 for interests in another vehicle advised by the adviser.
The rule also requires advisers to distribute to the private fund’s investors a summary of any material business relationships the adviser has, or has had within two previous years, with the independent opinion provider.
“This requirement will provide a check against an adviser’s conflicts of interest in structuring and leading such transactions,” the SEC said.
In addition, the SEC revised the books and records rules under the Advisers Act to facilitate its ability to assess registered private fund advisers’ compliance with the rules.
“Private funds and their advisers play an important role in nearly every sector of the capital markets,” said SEC Chair Gary Gensler. “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.”
The final rules are in Release No. IA-6383, Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews. The rules become effective 60 days after publication in the Federal Register.
Additional Requirements
Release No. IA-6383 has other requirements, and these apply to all private fund advisers.
The rules restrict private fund advisers from engaging in certain activities that create conflicts of interest and have the potential to harm investors. Among other things, private fund advisers must not charge or allocate to the private fund fees or expenses associated with an investigation of the adviser without disclosure and consent from fund investors.
The SEC is also prohibiting private fund advisers from providing investors with preferential treatment related to redemptions and information if such treatment will have a negative consequence for other investors.
In addition, the rules amend the compliance rule under the Advisers Act. It requires all registered advisers, including those that do not advise private funds, to document the required annual review of their compliance policies and procedures.
“Written documentation of the annual review will help the Commission to determine advisers’ compliance with the with the rules and identify potential compliance program weaknesses,” the SEC stated.
Vote Along Party Line
There was a mixed reaction to the SEC’s decision to adopt the rules.
Senator Sherrod Brown, a Democrat from Ohio who chairs the Senate Banking Committee, applauded the SEC’s action. He has previously supported the commission’s proposal in comment letters, saying that the rules would enhance transparency in the private fund market and protect investors from conflicts and harmful practices.
“These rules will help protect workers’ pensions and create a more transparent and accountable private funds market,” Brown said in a statement.
However, Patrick McHenry, a Republican from North Carolina who chairs the House Financial Services Committee, criticized the SEC.
“Once again, Chair Gensler’s SEC is exceeding its statutory authority to impose onerous and costly mandates—this time on private funds,” McHenry said in a statement. “By applying a framework designed for retail funds used by everyday investors to private funds, this rule fails to acknowledge the differences between these markets. Instead of pursuing this one-size-fits-all approach, the SEC should be working to strengthen our public markets and create new opportunities for all investors to save and build wealth through our private markets—just like Republicans have done with our capital formation agenda. I urge the SEC to rescind this ill-advised rule, which is a thinly veiled attempt to dictate private fund management.”
The SEC’s decision to adopt the rules reflected the lawmakers’ views. Conservative Commissioners Hester Peirce and Mark Uyeda voted against the final rules.
Compliance Burdens
Now that the rules are in place, advisers will have to prepare for implementation. And the requirements are expected to be burdensome.
“Given that most advisers of private funds are already transparent about their fees, conflicts of interest, and other information, the new rules may cause frustrations because they impose heightened compliance standards,” said Timothy Selby, a partner with Alston & Bird LLP in New York. “Larger fund managers likely have resources in place to fall in line, but it may strain others.”
The SEC set different compliance dates depending on the provisions in the final release.
For quarterly statement and audit rules, the compliance date is 18 months after the release’s publication in the register.
For the adviser-led secondaries rule, the preferential treatment rule and the restricted activities rule, the compliance dates are: for advisers with $1.5 billion or more in private funds assets under management, 12 months after publication in the register; and for advisers with less than $1.5 billion in private funds assets under management, 18 months after publication in the register.
This article originally appeared in the August 24, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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