By Carter Farrell, Associate
On August 23, 2023, the Securities and Exchange Commission (“SEC”) adopted new rules and rule amendments to enhance the regulation of private fund advisers and update the existing compliance rule that applies to all investment advisers. The new rules and rule amendments represent a spreading change that increases the regulation of private funds.
Under the rules, registered private fund advisers must provide investors with quarterly statements that detail information about fund performance, fees and expenses. These requirements are intended to increase transparency as SEC Chair, Gary Gensler, stated in a press release “… enhancement of adviser transparency and integrity will help to promote greater competition and thereby efficiency.”
In addition to implementing rules regarding increased transparency among SEC Registered Private Fund Advisers, the SEC has also adopted rules that will apply to exempt reporting advisers. Exempt reporting advisers are not required to register as advisers with the SEC or most state regulators, but they are now subject to some of the same rules as registered private fund advisers.
The first new rule applicable to both SEC registered private fund advisers and exempt reporting advisers is the New Advisers Act Rule 211(h)(2)-3, commonly known as the Preferential Treatment Rule. Under this Rule, advisers must provide preferential treatment to all investors in terms of both redemption and transparency.
The redemption requirements prohibit an adviser and its related persons from granting an investor the ability to redeem its interest on terms that the adviser reasonably expects to have a material, negative effect on other investors in that private fund or similar pool of assets. The transparency requirements are similar in scope but concern the distribution of information to investors.
In addition to the prohibited preferential treatment requirements, it is now also mandatory for advisers to provide advance disclosure related to material economic terms or any other preferential treatment provided to other investors in the same private fund.
The second rule is the New Advisers Act Rule 211(h)(2)-1 (also known as the Restricted Activities Rule) which restricts private fund advisers from engaging in certain activities that are contrary to public interest and have the potential to harm investors. Some of these restrictions include:
- Charging or allocating to the private fund fees or expenses associated with an investigation of the adviser without disclosure and consent from fund investors.
- 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 certain taxes, unless pre-tax and post-tax amounts of clawback are disclosed to investors.
- Borrowing or receiving an extension of credit from a private fund client without disclosure or consent from fund investors.
For both the Preferential Treatment Rule and Restricted Activities Rule, the compliance date for advisers with less than $1.5 billion in private fund assets under management is 18 months after the date of publication in the Federal Register. For advisers with more than $1.5 billion in private fund assets under management, the compliance date is 12 months after publication.
Although the final rules are less strict than the originally proposed rules, this final set of rules has been met with some criticism. For one, there is worry that the rules will be a compliance burden for private fund advisers. In addition to the rules discussed above, registered private fund advisers will also be required to get an annual audit for each private fund they advise, directly or indirectly.
Larger fund managers likely have the resources to meet this heightened standard, but smaller fund advisers may be more strained in meeting the new compliance requirements which are far-reaching compared to previous regulation of private fund advisers by the SEC.
With the compliance date not coming into full effect for at least another year, it is too early to determine the effect the new rules will have on investors. However, private fund advisers, both registered and exempt reporting advisers, should begin preparing for compliance with their applicable rules. A more powerful microscope has certainly been placed on private fund advisers, so awareness of these rules should help ensure private fund advisers are cooperating with the SEC.
If you have any further questions regarding the new requirements for private fund advisers, please contact a member of Barton’s Financial Services, Investment Funds, and Regulatory Compliance Team.
