SEC Adopts New Rules for Private Fund Advisers

Practical Law Legal Update w-040-5271 (Approx. 4 pages)

SEC Adopts New Rules for Private Fund Advisers

by Practical Law Corporate & Securities

Registered Private Fund Advisers

Adopted rules and disclosure obligations applicable to registered private fund advisers include:

Quarterly Statements. New Rule 211(h)(1)-2 will require registered private fund advisers to prepare quarterly statements disclosing specified information and distribute them to the private fund's investors. The quarterly statements must be prepared in a clear and concise manner and include information relating to, among other things:
- fees and expenses paid by the private fund;
- the private fund's portfolio investments; and
- the fund's performance.
The SEC also amended Advisers Act Rule 204-2 (the recordkeeping rule) to require advisers to retain certain books and records relating to the quarterly statements requirement (for more on the recordkeeping rule, see Practice Note, Investment Adviser Regulation: Overview: Recordkeeping).
The Audit Rule. Rule 206(4)-10 will require registered fund advisers to cause each private fund they advise to undergo an annual audit that meets the requirements of Advisers Act Rule 206(4)-2 (the custody rule) (see Practice Note, Investment Adviser Regulation: Overview: Custody of Assets).
The Adviser-led Secondaries Rule. Rule 211(h)(2)-2 will require registered private fund advisers conducting an adviser-led secondary transaction to distribute to the private fund's investors:
- a fairness opinion or a valuation opinion from an independent opinion provider; and
- a written summary of any material business relationships between the adviser or any of its related persons and the independent opinion provider.

Notably, these rules do not apply to private fund advisers with respect to the securitized asset funds they advise, including collateralized loan obligations (CLOs).

All Private Fund Advisers

New rules applicable to all private fund advisers include:

The Restricted Activities Rule. Rule 211(h)(2)-1 aims to address conflicts of interest by prohibiting all private fund advisers from, subject to certain disclosure- and consent-based exceptions:
- charging or allocating to the private fund fees or expenses associated with an investigation of the adviser or its related persons by any governmental or regulatory authority;
- charging or allocating to the private fund any regulatory or compliance fees or expenses, or fees or expenses associated with an examination, of the adviser or its related persons;
- reducing the amount of an adviser clawback by actual, potential, or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders;
- charging or allocating fees or expenses related to an actual or potential portfolio investment on a non-pro rata basis when multiple private funds and other clients advised by the adviser or its related persons have invested in the same portfolio investment; and
- borrowing money, securities, or other private fund assets, or receiving a loan or extension of credit, from a private fund client.
Preferential Treatment Rule. Rule 211(h)(2)-3 prohibits, subject to certain exceptions, all private fund advisers from providing preferential treatment regarding redemption rights and portfolio holdings or exposure information if the adviser reasonably expects it would have a material, negative effect on other investors. The rule also establishes disclosure obligations requiring notice to prospective investors regarding preferential treatment provided to other investors in the private fund, regarding preferential treatment, including comprehensive post-investment disclosure regarding preferential treatment.

As with the quarterly statement, audit, and adviser-led secondaries rules, the restricted activities and preferential treatment rules will not apply to investment advisers with respect to the securitized asset funds they advise, including CLOs.

Registered Investment Advisers

The SEC also adopted amendments to Advisers Act Rule 206(4)-7 (the compliance rule) to require all registered investment advisers, including those that do not advise private funds, to document in writing their annual review of their compliance policies and procedures (for more on investment adviser compliance programs, see Practice Note, Investment Adviser Regulation: Overview: Compliance Program).

Compliance Date and Legacy Status

While the final rules will become effective 60 days after publication in the Federal Register, the compliance dates for the new and amended rules are as follows:

For the audit rule and quarterly statement requirement, 18 months after publication in the Federal Register.
For the adviser-led secondaries rule, preferential treatment rule, and restricted activities rule:
- 12 months after publication in the Federal Register for advisers with $1.5 billion or more in private funds assets under management; and
- 18 months after publication in the Federal Register for advisers with less than $1.5 billion in private funds assets under management.
For the amended Advisers Act compliance rule, 60 days after publication in the Federal Register.

The SEC also provided legacy status for the prohibitions aspect of the preferential treatment rule and for the aspects of the restricted activities rule requiring investor consent. The legacy status provisions apply to contractual agreements governing a private fund that were entered into before the compliance date if the rule would require the parties to amend the agreements.

SEC Adopts New Rules for Private Fund Advisers | Practical Law