New SEC Rules Aim to Protect Private Fund Investors

On August 23, 2023 the United States Securities and Exchange Commission (“SEC”) adopted new rules and amendments under the Investment Advisers Act of 1940 (“Advisers Act”) in an effort to protect private fund investors and make the private funds market more transparent, competitive and efficient.

The Final Rule issued by the SEC restricts private fund advisers (including those that are not registered with the SEC) from engaging in certain activities unless they provide specified disclosure to and (in some cases) obtain consent from investors, and regulates additional compliance procedures required of registered investment advisers.

Here is a brief summary of 7 critical points private fund managers should be aware of. [i]

What’s Required for All Private Fund Advisers

1. Restricted Activities Rule. This reform restricts all private fund advisers from engaging in certain activities that have the potential for conflict of interest which could harm investors, such as: (a) charging fees or expenses related to an investigation of the adviser without disclosure to (and consent from) fund investors, provided that an adviser may not (regardless of disclosure) charge such expenses if the investigation results in a sanction for a violation of the Advisers Act; (b) charging regulatory, examination, or compliance fees or expenses of the advisers unless disclosed; (c) reducing the amount of an adviser clawback by the amount of certain taxes (unless such fees and expenses are disclosed to investors); (d) 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 advanced written notice with a description explaining how the allocation approach is fair and equitable); and (e) borrowing or receiving credit from a private fund client without disclosure to (and consent from) fund investors. The compliance date will be 12 or 18 months after the date of publication in the Federal Register, depending on the size of the fund.
   ­
2. Preferential Treatment Rule. This reform prohibits all private fund advisers from providing preferential terms to investors (through side letters or otherwise) regarding: (a) certain redemptions (except for redemptions for regulatory reasons) that the adviser reasonably expects to have a material negative effect on other investors; (b) certain preferential information regarding portfolio holdings or exposures of a private fund to an investor if the adviser reasonably expects that providing such information would have a material, negative effect on other investors; and (c) preferential treatment unless: (i) material economic terms (i.e., cost of investing, liquidity rights, fee breaks, co-investment rights, etc.) are disclosed in advance, and (ii) all preferential terms that are not material economic terms are disclosed after investment. It is important to note that the SEC clarified the disclosure is not a simple disclaimer that other investors may have received preferential terms, but rather disclosure means a detailed description of the preferential treatment (for example, distribution of redacted copies of all side letters or a summary of all preferential terms with specific descriptions). The compliance date will be 12 or 18 months after the date of publication in the Federal Register, depending on the size of the fund.

It is important to note that the SEC specified that legacy status (discussed below) shall not apply to the disclosure requirements for investments that occur after the compliance date.

What’s Required for Registered Investment Advisers

3. Annual Compliance Review. All registered investment advisers shall be required to document the annual review of their compliance policies and procedures under Rule 206(4)-7 in writing. The compliance date will be 60 days after the date of publication in the Federal Register.
   ­
4. Quarterly Statement Rule. Registered investment advisers for private funds shall be required to provide investors with quarterly statements that detail fund performance, cost of investing, fees and expenses, and other amounts paid to the adviser. The compliance date will be 18 months after the date of publication in the Federal Register.
   ­
5. Private Fund Audit Rule. Registered investment advisers for private funds shall be required to obtain an annual financial statement audit of each private fund it advises. The compliance date will be 18 months after the date of publication in the Federal Register.
   ­
6. Adviser-Led Secondaries Rule. Registered investment advisers for private funds shall be required to obtain a fairness opinion or valuation opinion from an independent third party. The compliance date will be 12 or 18 months after the date of publication in the Federal Register, depending on the size of the fund.
   ­
7. Books and Records Rule Amendments. The SEC is in the process of adopting corresponding amendments to the Advisers Act books and records rule that will clarify the compliance requirements.

The new rules do not apply to investment advisers with respect to securitized asset funds. A Securitized Asset Fund is “any private fund whose primary purpose is to issue asset backed securities and whose investors are primarily debt holders”. Special legacy status provisions adopted by the SEC provide that funds which have already commenced operations and have written governing agreements prior to the compliance date listed for each rule will be exempt from compliance.[ii]

This document is intended to provide only a general background ‎regarding this matter. This document should not be regarded as binding legal advice, but rather a practical overview based on ‎our understanding. APM & Co. is not licensed to practice law outside of ‎Israel.

APM Fund Formation Team.

[i] United States Securities and Exchange Commission. Press Release 2023-155 (August 23, 2023). SEC Enhances the Regulation of Private Fund Advisers, https://www.sec.gov/news/press-release/2023-155.

[ii] United States Securities and Exchange Commission. Final Rule. Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews (August 23, 2024), 17 CFR Part 275, https://www.sec.gov/files/rules/final/2023/ia-6383.pdf.