The SEC’s Focus On Transparency With New Rules for Registered Private Fund Advisers

On August 23, 2023, the Securities and Exchange Commission (“SEC”) approved new rules and regulations related to both Registered Private Fund Advisers (“Advisers”) and Non-Registered Advisers (“NRA”). The changes focus on enhancing transparency between Advisers and their investors.

While many private funds already obtain annual audits due to provisions in their Limited Partnership Agreements, the new rules require all private funds to obtain audited financial statements, thereby removing the ability of Advisers to rely on a surprise examination for compliance purposes. In addition, they will be required to furnish quarterly financial statements to all investors, detailing quarterly fees and fund performance, within 45 days for the first quarters of the year and 90 days for year-end (75 and 120 days, respectively, for fund of funds). These rules also aim to increase fee transparency so investors can better understand fees and expenses paid to the Adviser.

In another rule to enhance fee transparency, the SEC has prohibited any fees or charges associated with “Restricted Activities” of both Advisers and NRAs to be allocated to the investors in the private funds an adviser manages (unless fully disclosed to investors). These Restricted Activities include regulatory fees, compliance fees, examination fees, or any fees associated with an investigation of the Adviser. Additionally, unless an Adviser provides written notice to investors of both the post- and pre-tax amounts to investors within 45 days of the end of each quarter, Advisers will be prohibited from reducing clawbacks by specific tax amounts.

A common practice within the industry is using “Side Letters” which often provide certain investors (often more prominent investors) with better fees and redemption terms, such as reduced management fees or redeeming investments without any qualifications. Under the new Preferential Treatment Rule, preferential redemption terms or preferential portfolio investment information provided to certain investors has been prohibited. Any other preferential treatment (ie, reduced management fees) provided to certain investors must be disclosed to all investors before investing into a fund. Any Advisers with existing agreements or Side Letters with investors would be grandfathered in if the agreements were entered into prior to the compliance date of the new rules. Advisers will have to rethink strategies to court larger investors to invest their assets with the Adviser’s private funds.

Lastly, the Adviser-Led Secondaries Rule requires Advisers to obtain a fairness or valuation opinion when offering investors to transfer positions from one fund to another or when offering investors to cash out their positions.The Adviser will also be required to disclose any material business relationships with the opinion provider that existed within two years before the issuance of the opinion.

Compliance with a majority of the new rules will be required between 12 and 18 months from when the rules are published in the Federal Register, depending on an Adviser’s assets under management. Rules related to documentation of annual compliance reviews must be complied with within 60 days.

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