On August 23, 2023, the SEC adopted new rules under the Investment Advisers Act of 1940 (the Advisers Act) that significantly increase the regulation of private fund advisers. As previewed by the SEC’s original February 2022 proposal, the final rules establish a more prescriptive, rules-based regulatory regime for private fund advisers designed to protect investors through increased transparency, competition and efficiency in the private fund market. However, the final rules include a number of meaningful changes that, in general, reduce the burdens on advisers compared to the 2022 proposal.
In an important departure from the originally proposed “prohibited activities rule,” the final rules impose disclosure and, in some cases, consent requirements (but generally do not ban) certain activities that could involve conflicts of interest between an adviser and its private fund clients (and investors). Specifically, all private fund advisers, including those that are not registered with the SEC (such as exempt reporting advisers and state-registered advisers), are prohibited from:
- charging a fund or investors for fees or expenses associated with a regulatory investigation of the adviser or its related persons without written consent from a majority in interest of third-party investors. However, if an investigation results in the imposition of a sanction for a violation of the Advisers Act, no fees or expenses related to such investigation may be charged to the fund or investors;
- charging a fund or investors regulatory, examination or compliance fees or expenses of the adviser or its related persons, unless such fees and expenses are disclosed in writing to investors within 45 days after the end of the fiscal quarter in which the charge occurs;
- reducing the amount of any adviser clawback by taxes applicable to the adviser, its related persons or their respective owners or interest holders, unless the adviser discloses the pre-tax and post-tax amount of the clawback in writing to investors within 45 days after the end of the fiscal quarter in which the clawback occurs;
- charging a fund or investors for fees or expenses related to a portfolio investment on a non-pro rata basis when multiple managed funds invest, unless (i) the allocation approach is fair and equitable and (ii) the adviser distributes to investors 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 from a fund client without (i) disclosure of the material terms of the borrowing and (ii) obtaining written consent from a majority in interest of third-party investors. In its release the SEC clarified that the restriction on borrowing is not intended to apply to typical tax advances made to private fund sponsors.
The SEC’s proposed prohibitions from the 2022 proposal on (i) seeking reimbursement, indemnification, exculpation or limitation of liability for a breach of fiduciary duty, willful misfeasance, bad faith, negligence or recklessness in providing services to a fund and (ii) charging portfolio companies accelerated fees or other fees for unperformed services were not included in the final rules (although the SEC noted in its release that it believed it was unnecessary for the final rules to prohibit an adviser from charging such fees because such activity “already is inconsistent with the adviser’s fiduciary duty”).
The final rules include a revised “preferential treatment rule” that prohibits all private fund advisers, including those not registered with the SEC, from providing preferential treatment to certain investors regarding:
- redemptions of fund interests on terms that the adviser reasonably expects to have a material, negative effect on other investors, unless (i) the ability to redeem is required by law or (ii) the adviser offers the same redemption rights to all investors;
- information relating to portfolio holdings or exposures if the adviser reasonably expects that providing such information would have a material, negative effect on other investors, unless such information is offered to all investors at the same time;
- material economic terms, unless the adviser provides written notice of the specifics of such preferential treatment to all prospective investors prior to their investment; and
- any other preferential treatment, unless the adviser provides written disclosure to investors of all preferential treatment as soon as reasonably practicable following the end of the fund’s fundraising period (for an illiquid fund) or following an investor’s investment (for a liquid fund).
Additionally, on at least an annual basis, an adviser must provide a written notice to investors that provides specific information regarding any preferential treatment provided to other investors since the last written notice provided in accordance with the rule.
Quarterly Reporting Requirements
Consistent with the original proposal, the final rules impose standardized quarterly reporting requirements on private fund advisers registered with the SEC (but not, e.g., exempt reporting advisers or state-registered advisers) requiring disclosure to investors of fund performance, investment costs, fees and expenses and manager compensation. The reports will be due within 45 days after the end of the fund’s first three fiscal quarters and within 90 days after the end of the fund’s fiscal year (75 and 120 days, respectively, for a fund of funds).
Adviser-Led Secondary Transactions
The final rules require registered private fund advisers to obtain either a fairness opinion or, in an addition to the 2022 proposal, a valuation opinion from an independent opinion provider in connection with any adviser-led secondary transaction. The final rules also require the adviser to prepare and distribute to investors (prior to the due date of investors’ election forms for participation in the transaction) a written summary of any material business relationships the adviser has, or has had within the prior two years, with the independent opinion provider.
Private Fund Audits
Consistent with the 2022 proposal, the final rules require a registered adviser to obtain an annual financial statement audit of each private fund it advises. In a helpful change from the proposal, however, such audits must satisfy the requirements of the audit provision in the Advisers Act custody rule (Rule 206(4)-2), thereby eliminating potentially conflicting requirements for audits under this rule and the custody rule.
Compliance and Books and Records Rules
The SEC amended the Advisers Act’s (i) compliance rule (Rule 206(4)-7) to require all registered advisers, including those that do not manage private funds, to document in writing the annual review of their compliance policies and procedures and (ii) books and records rule (Rule 204-2) to require registered advisers to retain books and records to facilitate compliance with the final rules discussed above.
The final rules’ requirements regarding quarterly statements and private fund audits have a compliance date of 18 months after publication in the Federal Register. For the preferential treatment rule, the restricted activities rule and the final rules’ requirements related to adviser-led secondaries, the compliance dates are: for advisers with $1.5 billion or more in private fund assets under management, 12 months after publication in the Federal Register; and for advisers with less than $1.5 billion in private fund assets under management, 18 months after publication in the Federal Register. Compliance with the amended Advisers Act compliance rule will be required 60 days after publication in the Federal Register.
In a major beneficial change from the 2022 proposal, the final rules provide “legacy status” (i.e., grandfathering) for:
- the prohibitions aspects of the preferential treatment rule (i.e., redemptions and portfolio information); and
- the aspects of the restricted activities rule that require investor consent (i.e., restricting an adviser from borrowing from a private fund and from charging for certain investigation fees and expenses).
This legacy status eliminates the need for funds already in existence to amend side letters and other fund documentation that may run afoul of these rules. However, the SEC’s adopting release clarifies that legacy status will only apply to agreements entered into in writing prior to the compliance date with respect to private funds that have commenced operations as of the compliance date. The commencement of operations includes any bona fide activity directed towards operating a private fund, including investment, fundraising or operational activity.
We will continue to digest the new rules and will be in touch in the near future with additional thoughts and updates. However, while the compliance dates seem far off, private fund advisers should begin to consider the rules’ impacts on their business, including:
- whether the adviser currently engages in any restricted activities and, if so, how it will comply with the disclosure (and with respect to any non-grandfathered future funds, consent) requirements;
- whether the adviser grants preferential treatment to certain investors and, if so, how it intends to comply with the disclosure requirements (in particular, with respect to preferential treatment regarding material economic terms which must be disclosed to all investors prior to their investment in a private fund);
- how the adviser will collect data for, and calculate, the information required in quarterly reports, as well as whether any new service providers (administrators, financial printers, etc.) will be engaged to assist in the process;
- which additional entities, if any, in an adviser’s fund structures will need an audit; and
- the need to implement new policies and procedures to comply with the amended compliance rule and the new requirements of the amended books and records rule.
 A “private fund” is an issuer that would be an investment company, as defined in Section 3 of the Investment Company Act of 1940, but for Section 3(c)(1) or 3(c)(7) of that Act. However, the final rules generally exclude securitized asset funds from this definition.
 In the final rules’ adopting release, the SEC reiterated its historical position that most of the substantive provisions of the Advisers Act do not apply with respect to the non-U.S. clients (including funds) of a registered offshore adviser.
 An “adviser clawback” is defined as any obligation of the adviser, its related persons or their respective owners or interest holders to restore or otherwise return performance-based compensation to the private fund pursuant to the private fund’s governing agreements.
 The SEC separately announced that it has reopened the comment period on its “safeguarding rule” proposal, which includes major changes to the custody rule. A previous alert discussing this proposal can be found here.
 Legacy status does not permit advisers to charge for fees or expenses related to an investigation that results or has resulted in a regulator or court imposing a sanction for a violation of the Advisers Act.