The New SEC Private Fund Adviser Rules: Understanding the Basics
The phenomenal growth of private funds
There has been a huge increase in assets in private funds over the past five years. The assets under management of private equity funds grew from $2.9 trillion to $6.5 trillion from 2017 to 2022. There are now over 5,500 registered investment advisers with at least one private fund offering. As private markets grow in importance, they have attracted increased scrutiny from regulators concerned about investor protection and disclosure around potential conflicts of interest.
New rules aim to manage risks
In August 2023, the Securities and Exchange Commission (SEC) adopted new rules and amendments, primarily under the Investment Advisers Act of 1940, to enhance the regulation of private fund General Partners (GPs). The stated goals of the regulations are to protect those who directly or indirectly invest in private funds by increasing visibility into certain practices, establishing requirements to address practices that have the potential to lead to investor harm, and prohibiting or restricting adviser activity that is contrary to the public interest and the protection of investors.
What you need to know.
There are five main components of the requirements for advisers involved with private funds:
- Annual Audit Rule. Advisers will need to obtain an independent annual financial statement audit for each private fund they directly or indirectly advise, which must meet the requirements of the audit provision in the Advisers Act custody rule.
- Quarterly Reporting Rule. Advisers must disclose a standard set of details and performance data, with the rules providing definitions for commonly used reporting metrics, such as the net and gross internal rate of return.
- Adviser-led Secondaries Rule. Advisers must obtain a fairness or valuation opinion from an independent provider when offering existing investors the option to sell their interests in a private fund and convert or exchange them for interests in another vehicle advised by the adviser.
- Restricted Activities Rule. Certain fees must be disclosed to investors, including expenses associated with regulatory, examination, or compliance fees.
- Preferential Treatment Rule. To increase investor transparency, all side letter terms with limited partners (LPs) must be disclosed. In addition, certain provisions cannot be offered to one investor unless they are offered to all (e.g., preferential redemption provisions and preferential information about portfolio holdings or exposures).
Who needs to comply?
Most private fund advisers are in scope, but the SEC called out several key exceptions: Securitized asset funds, defined as any private fund whose primary purpose is to issue asset backed securities and whose investors are primarily debt holders, have been excluded from the rules. This means that collateralized loan obligations (CLOs) and a variety of other fund structures are out of scope. In addition, exempt reporting advisers (ERAs), a category that includes many venture capital firms, are excluded from the Audit, Quarterly Statement, and Adviser-led Secondaries Rules.
When will the new rules go into effect?
Different components of the rules have different implementation timelines that will go into effect after the rules are published in the Federal Register:
- The Audit and Quarterly Statement Rules have an 18-month timeline for all private fund advisers.
- The Adviser-led Secondaries, Restricted Activities, and Preferential Treatment Rules have a 12-month timeline for larger advisers (i.e., $1.5B+ in AUM) and an 18-month timeline for smaller advisers (i.e., less than $1.5B in AUM).
In addition, adherence with the amended Advisers Act Compliance Rule will be required 60 days after publication in the Federal Register. This requires all registered advisers, including those who do not advise private funds, to document in writing the required annual review of the adequacy of compliance policies and procedures and the effectiveness of their implementation.
In addition to the new Private Fund Rules, other reporting changes on related topics are already in force. In May 2023, the SEC made updates to the requirements around the Form PF, the confidential reporting form for certain SEC-registered investment advisers to private funds. Private equity fund advisers must now report recent adviser-led secondary transactions on a quarterly basis within 60 days of the fiscal quarter end.
Are there retroactive requirements?
Critically, the SEC has clarified that the Preferential Treatment Rule will not apply retroactively, which means that past client agreements will not have to be amended to comply with the rules.
Do the rules apply outside the U.S.?
Non-U.S. fund managers are generally not in scope, regardless of whether they have U.S. investors. However, the industry is still studying the global implications of the regulations.
Implications for private fund managers.
The new rules create a complex set of compliance issues for private fund managers. Most GPs will likely need to enhance one or more of their current valuation, reporting, or data collection processes to comply.
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