On August 23, 2023, the Securities and Exchange Commission adopted new rules and rule amendments (Release No. IA-6383) under the Investment Advisers Act of 1940 (Advisers Act) to enhance the regulation of private fund advisers and update the existing compliance rule that applies to all investment advisers. The new rules and amendments are designed to protect private fund investors by increasing transparency, competition, and efficiency in the private funds market. Highlights include:

The Private Fund 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 Private Fund Rules prohibit all private fund advisers from 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 from 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.

The amendments will also require all registered advisers to document in writing the annual review of their compliance policies and procedures.

For Registered Private Fund Advisers:

Quarterly Statement Rule. New Rule 211(h)(1)-2 requires 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. New Rule 206(4)-10 requires 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), including the requirement that the audit must be performed by an independent public accountant registered with the PCAOB. The SEC believes 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 registered private fund adviser must maintain a copy of each private fund’s audited financial statements.

Adviser-Led Secondaries Rule. New Rule 211(h)(2)-2 requires 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. Each fairness opinion or valuation opinion must be provided by an independent opinion adviser – a person who provides fairness opinions or valuation opinions in the ordinary course of its business and is not a related person of the adviser. 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. The purpose of this requirement is to provide a check against an adviser’s conflicts of interest in structuring and leading such transactions.

For All Private Fund Advisers:

Restricted Activities Rule. To address certain conflicts of interest that have the potential to lead to investor harm, new Rule 211(h)(2)-1 restricts all private fund advisers, regardless of their SEC registration status, from engaging in the following activities:

– Charging or allocating to the private fund fees or expenses associated with an investigation of the adviser without disclosure and consent from fund investors.  Additionally, 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 actual, potential, or hypothetical 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, new Rule 211(h)(2)-3 prohibits all private fund advisers from granting 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 prior to the compliance date if the applicable rule would require the parties to amend the agreements.

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 (including CLOs).

For All Registered Advisers:

Compliance Rule. The SEC adopted amendments to Rule 206(4)-7(b) to require 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.

Books and Records Rule Amendments. To facilitate the SEC’s ability to assess an adviser’s compliance with the rules, the SEC amended Rule 204-2 to require advisers to retain books and records related to the Quarterly Statements Rule, Audit Rule, Adviser-Led Secondaries Rule, Preferential Treatment Rule, Restricted Activities Rule and
Compliance Rule.

The full text of Release No. IA-6383 is available at https://www.sec.gov/files/rules/final/2023/ia6383.pdf