United States: SEC Adopts Final Rules For Private Fund Advisers

On August 23, 2023, the Securities and Exchange Commission ("Commission" or "SEC") adopted the much-anticipated final rules ("Final Rules") for private fund advisers ("Private Fund Advisers") under the Investment Advisers Act of 1940 ("Advisers Act" or "Act"), which have already sparked controversy in the private funds industry. Below is a brief summary of the Final Rules.

Rules Applicable to All Private Fund Advisers

• A Private Fund Adviser will be restricted from charging its private fund clients for its or its related persons' regulatory or compliance fees or expenses or fees or expenses related to any governmental or regulatory examination, unless the Private Fund Adviser gives a detailed quarterly accounting of each category of the fees or expenses.
• A Private Fund Adviser will be restricted from reducing the amount of its clawback obligation by the amount of taxes applicable to the adviser, its related persons or their respective owners or interest holders, unless the adviser delivers disclosure of the aggregate dollar amount of the clawback before and following the reduction for taxes.
• If a Private Fund Adviser has more than one client that invests or proposes to invest in a portfolio investment, the adviser will be prohibited from charging or allocating fees and expenses related to the portfolio investment or prospective portfolio investment to a private fund client on a non-pro rata basis, unless the allocation is fair and equitable under the circumstances and, before charging or allocating the fees or expenses, the adviser distributes a written notice of the non-pro rata charge or allocation and a description of how it is fair and equitable under the circumstances.
• A Private Fund Adviser will be restricted from borrowing money, securities or other fund assets, or receiving a loan or an extension of credit from a private fund client, unless the adviser distributes written notice and a description of the material terms of the borrowing to investors in the private fund, seeks consent to the borrowing from all investors in the fund and obtains written consent from at least a majority in interest of the fund's investors that are not related persons of the adviser.
• A Private Fund Adviser will be prohibited from, directly or indirectly, granting preferential redemption rights to an investor in a private fund or a similar pool of assets if the adviser reasonably expects that the terms of the preferential redemption rights would have a material, negative effect on other investors in the private fund or a similar pool of assets. Exceptions exist where redemption rights are required by law, rule, regulation or order or where redemption rights are granted equally to all existing and future investors.
• A Private Fund Adviser will be prohibited from, directly or indirectly, granting preferential information rights regarding portfolio holdings or exposures of a private fund to an investor in a private fund or a similar pool of assets if the adviser reasonably expects that providing the information would have a material, negative effect on other investors in the private fund or a similar pool of assets. An exception exists where the same information rights are granted to all other investors in the private fund or similar pool.
• A Private Fund Adviser will be prohibited, directly or indirectly, from granting any preferential rights to any investor in a private fund, unless the adviser delivers certain specific written disclosure regarding the preferential treatment.
• The Commission will not apply certain portions of the Final Rules to existing funds and their existing contractual agreements ("legacy status"), including, (i) the prohibitions under the preferential treatment rule relating to preferential redemption and information rights, (ii) aspects of the restricted activities rule that require investor consent and restrict a Private Fund Adviser from borrowing from a private fund or charging private fund clients certain investigation fees or expenses. Limitations to legacy status apply.

Rules Applicable to SEC-Registered Private Fund Advisers

• An SEC-registered Private Fund Adviser will be required to deliver quarterly statements for each private fund it advises containing a table with comprehensive information relating to the fund's fees and expenses and compensation paid or allocated by the fund to the adviser or its related persons during the reporting period, as well as the amount of offsets or rebates against adviser compensation carried forward during the reporting period to subsequent quarterly periods.
• Each private fund advised by an SEC-registered Private Fund Adviser is required to have an annual and liquidation financial statement audit under Generally Accepted Auditing Standards that satisfies the requirements of the custody rule for pooled investment vehicles. Each audit is to be performed by a public accountant that meets the required independence standards. The resulting audited financial statements must be delivered to private fund investors in accordance with the custody rule. Unlike with the custody rule, under the Final Rules surprise examinations will not be an acceptable substitute for an audit.
• An SEC-registered Private Fund Adviser will be prohibited from initiating a transaction that offers private fund investors the opportunity to elect to sell all or a portion of their interests in a private fund or exchange or convert such interests for interests in a new investment vehicle advised by the Private Fund Adviser ("adviser-led secondaries"), unless the Private Fund Adviser obtains a fairness opinion or a valuation opinion from an independent opinion provider; the opinion is distributed to investors in the fund before the election is due from the investors; and the Private Fund Adviser provides, together with the opinion, a written summary of any material business relationship between it or its related persons and the opinion provider.
• The Commission is imposing substantial new recordkeeping requirements on SEC-registered Private Fund Advisers pertaining to quarterly statements, audits, adviser-led secondary transactions and preferential treatment. In addition, the Commission separately amended the Advisers Act compliance rule (Advisers Act Rule 206(4)-7) to require all SEC-registered investment advisers to document in writing the annual review of their compliance program to assess the adequacy of their compliance policies and procedures and the effectiveness of implementation.

Compliance Dates

The Final Rules will be effective 60 days after their publication in the Federal Register. Private Fund Advisers with less than $1.5 billion in private fund assets under management will have an 18-month transition period after the effective date of the Final Rules. Private Fund Advisers with $1.5 billion or more in private fund assets under management will have an 18-month transition period to comply with the Quarterly Statement Rule and the Audit Rule and a 12-month transition period to comply with the Adviser-Led Secondaries, Preferential Treatment and Restricted Activities Rules.