The private funds radar is our regular roundup of developments from around the world for private fund stakeholders.
US
Private fund adviser rule overturned
In an eagerly awaited judgment, the US Court of Appeals for the Fifth Circuit on 5 June 2024 overturned the SEC's private fund adviser rule.
The SEC adopted the rule in August 2023. Imposing a set of five different obligations (relating to restricted activities, preferential treatment for investors, quarterly statements, audits, adviser-led secondaries and written annual reviews) the rule's application to a private fund sponsor would have varied depending on the sponsor's registration status with the SEC, its domicile (US or non-US) and the domicile of its private funds (as described in our quick guide).
But following the court's unanimous decision, the rule has been thrown out in its entirety: none of the rule's obligations will come into force. Private fund sponsors (both US and non-US) can halt their preparations to comply with the rule's requirements.
Underpinning the decision was the court's view that, in adopting the rule, the SEC had exceeded its rule-making powers. In short, the SEC did not have a general authority under the Investment Advisers Act to regulate private fund sponsors; nor could it rely on its sweeping powers under the Act's "anti-fraud" provisions to make the rule (to do so, the SEC should first have defined a fraudulent act or practice on the part of private fund sponsors, which the rule would then have been intended to prevent).
The judgment could have significant ramifications both for the SEC's future rulemaking plans and for existing SEC rules founded on the anti-fraud provision. Further challenges to SEC rules (both proposed and existing) cannot be discounted.
The SEC can appeal the Fifth Circuit's decision (it has 90 days to petition the US Supreme Court for an appeal), but it is unclear if it plans to do so. The timing of the approaching US presidential election may also be factor in any decision to appeal; it is possible that a future Democrat administration may look to legislate to give the SEC the specific powers it needs to bring the rule back. We will continue to monitor developments in this space.
ILPA to resume its quarterly reporting standards initiative
The Institutional Limited Partners Association (ILPA) has announced that it will resume its quarterly reporting standards initiative (QRSI). It had paused the initiative following the overturning of the SEC's private fund adviser rule (see above).
ILPA regarded the quarterly statements rule (one of the constituent parts of the private fund adviser rule) as "a catalyst necessary to accelerate the industry's adoption of minimum reporting standards".
The QRSI aims to create quarterly reporting standards that can be adopted across the industry, through standardised ILPA reporting templates.
In light of the court's judgment overturning the private fund adviser rule, ILPA and the QRSI will work on updating the scope of its reporting templates, with a view to publishing the revised templates for public comment in the near future.
SEC fines private fund sponsor for recordkeeping failures
An SEC-registered private fund sponsor agreed to pay a $6.5m fine in settlement of SEC charges that it failed, amongst other things, to keep copies of electronic messages sent between its personnel.
In particular, the sponsor's personnel used "personal texting platforms" and other electronic communication services, in breach of the sponsor's internal policies and procedures. As a result, the sponsor did not have copies of these messages on file, as required by US federal securities laws applicable to registered investment advisers (RIAs).
The SEC also found that senior personnel at the sponsor discussed the firm's business on personal devices using "off-channel communications" (i.e., private messaging), with those devices set to delete messages automatically after 30 days.
For all sponsors, but particularly those with a US RIA in their group, this case serves as a useful reminder of the perils of using personal devices and private messaging apps for work-related discussions.
FinCEN and SEC propose new AML requirements for SEC-registered investment advisers and exempt reporting advisers
The US Department of the Treasury's Financial Crimes Enforcement Network (FinCEN) and the SEC have jointly proposed a new rule that would require SEC-registered investment advisers (RIAs) and exempt reporting advisers (ERAs) to prepare and maintain "customer identification programs", as part of their anti-money laundering and counter terrorist financing policies.
In line with the SEC's normal approach to regulating non-US sponsors with non-US funds, we do not anticipate that FinCEN or the SEC will look to apply the new rule (if adopted) to non-US ERAs – but non-US RIAs will be in scope. This helpful briefing note by Paul, Weiss explains the details of the proposed rule. We will keep an eye on the rule's progress; the proposal is currently out for public comment until 22 July 2024.
Updated QPAM exemption rules now in force
Amendments to the qualified professional asset manager (QPAM) exemption are now in force. The amendments had been previously announced by the US Department of Labor (DOL).
The QPAM exemption is often used by private fund sponsors who are SEC-registered investment advisers (RIAs) with a significant ERISA investor base, and who are unable to structure their private funds to make use of other available exemptions (e.g., the VCOC/REOC exemptions or the "less than 25%" exemption). Broadly, the QPAM exemption permits a QPAM, on behalf of a fund or managed account, to enter into transactions that might otherwise be prohibited under the ERISA or the Internal Revenue Code.
We see many private fund sponsors looking at the QPAM exemption, as they find the "less than 25%" exemption harder to comply with, given the increasing prevalence of funds with currency and levered sleeves.
Key features of the updated rules include: (a) a requirement to notify the DOL within 90 days of first reliance on the QPAM exemption (the DOL intends to maintain a publicly-available list of all QPAMs); (b) an expansion of the list of actions that disqualify a firm from using the QPAM exemption to include non-US crimes that are substantially equivalent to the existing list of US crimes (this will be of particular practical concern to international sponsor groups with non-US operations); (c) increases in the minimum equity capital and assets under management thresholds to be eligible for the QPAM exemption; and (d) a requirement that QPAMs ensure transactions are based on their own independent judgment and free from bias in favour of parties-in-interest (to address the risks associated with a party-in-interest hiring a QPAM to approve a proposed transaction).
UK
Amendments to the Limited Partnership Act deferred to 2026
We noted in a previous Radar that the Economic Crime and Corporate Transparency Act 2023 (ECCTA) will make a suite of amendments to the Limited Partnerships Act 1907 (the Act) – the principal statutory framework for UK limited partnerships, including funds and ancillary vehicles (e.g. carried interest vehicles) structured as UK private fund limited partnerships.
In a progress report on the implementation of ECCTA, the Department for Business & Trade stated that the reforms to the Limited Partnerships Act 1907 are expected to come into effect during 2026. This is subject to the parliamentary timetable and may be further affected by the legislative priorities of a new government, following on from the UK general election.
UK anti-greenwashing rule now live
The FCA's general anti-greenwashing rule went live at the end of May 2024. The rule requires all FCA authorised firms to ensure their sustainability claims are fair, clear, and not misleading.
The rule has a wide scope, affecting all firms regardless of their direct involvement in sustainable business, and applies to all forms of communication with both professional and retail clients.
The anti-greenwashing rule is the first part of the FCA's Sustainability Disclosure Requirements (SDR) to be in force. We have prepared a quick guide to the SDR for private fund sponsors – please reach out to your usual Macfarlanes contact for a copy. Emma Garnham, a senior associate in our team, also recently joined Ignites Europe for a quick discussion on the implementation of SDR – you can watch her interview here.
FCA guide: common errors when applying for FCA authorisation
The FCA has published a note on its website, specifically for asset managers (including private fund sponsors), listing out some of the errors and issues that commonly crop up on applications for FCA authorisation. As such, this is well worth reading for start-up sponsors and for established firms considering obtaining an authorised for a new group entity.
Common issues noted by the FCA include:
- senior management lacking experience or qualifications;
- firms misunderstanding the requirement for the "mind and management" of a firm to be in the UK;
- firms failing to identify the risks that their business model poses and/or failing adequately to consider and evidence how they might remove or mitigate those risks;
- firms failing to appreciate that, where they outsource activities, they retain responsibility for those activities;
- a failure to consider potential conflicts of interest adequately or at all;
- seeking an exemption from the Financial Ombudsman Service (FOS) and/or the Financial Services Compensation Scheme (FSCS) when it is not appropriate to do so; and
- firms submitting applications when they are not yet ready, willing and/or organised to carry out their intended activities (for instance, before recruiting the relevant senior management function holders or before arranging for sufficient capital to be in place).
The FCA confirmed that the completeness and clarity of an application directly affects the speed with the application is determined.
EU
ESMA opinion on SFDR
ESMA, together with the EBA and EIOPA, has issued an opinion on the Sustainable Finance Disclosure Regulation (SFDR).
The opinion and accompanying press release acknowledge that the current SFDR regime is "complex by nature and difficult to understand". Consumer testing has found the prescribed SFDR disclosure templates to be "complicated and hard to read". The opinion also notes that the use of article 8 and article 9 labels potentially poses greenwashing and mis-selling risks.
The opinion recommends a move away from using the article 8/9 categorisation as a "quality label" and instead suggests the adoption of two voluntary product categories, "sustainable" and "transition".
The opinion was provided to the European Commission to assist in its deliberations over how to improve the EU's European framework for sustainable finance.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.