An Early Glimpse into the SEC’s Private Funds Advisor Rule

The Securities and Exchange Commission (SEC) has adopted the long awaited “Private Fund Adviser Rule” (the “PFA”). The proposed PFA was introduced on February 9, 2022 (“Proposed Rule”), and the SEC has been working with the General Partner and Limited Partner communities over the past 16 months or so to finalize the rule. The final rule (“Final Rule”) scales back the proposed rule, though ostensibly still enhances the regulatory landscape for private fund advisers under the Investment Advisers Act of 1940. The SEC's fact sheet provides an initial summary, and the Final Rule can be downloaded on the SEC’s website. Here’s a quick overview of what you need to know:

1. Enhanced Reporting and Transparency

• Quarterly Statements: Private fund advisers registered with the SEC will now be required to distribute quarterly statements to their investors. These statements will detail the fund’s performance, fees, expenses, and certain payments made to the adviser.
• Mandatory Annual Audits: Every private fund advised by registered entities will undergo a yearly financial statement audit. This move aims to ensure accurate valuation of private fund assets and safeguard against any misappropriation.
• Adviser-Led Secondaries: When offering existing fund investors an option to sell or exchange their interests, advisers will need to get a fairness or valuation opinion. Furthermore, they need to disclose any significant business ties with the entity providing this opinion.

2. Restricting Questionable Practices

• Restricted Activities: The new rules would disallow certain practices that may not align with public interest or investor protection. Examples include (i) charging investigation-related fees without disclosure or consent, (ii) tax adjusting the adviser’s carried interest clawback without reporting the clawback amount both with and without taxes, or (iii) allocating expenses to fund investors on a non-pro rata basis without proper notice.
• Fair Play: The rule seeks to ban preferential treatment, such as giving certain investors exclusive redemption rights or exclusive insights into portfolio holdings. There are exemptions, but these have to be disclosed to all investors.

3. Rigorous Compliance Requirements. Every registered adviser will need to document their annual review of compliance policies in writing. This amendment aims to help the SEC ascertain adherence to rules and spot potential areas of concern.

4. Legacy Status and Applicability. Certain provisions, like those requiring investor consent, will be given legacy status. This means they'll apply to governing agreements made before the compliance date, if amendments are needed.

5. Differences from the Proposed Rule. Several provisions that were included in the Proposed Rule were not included in the final adoption. For example, notably absent from the Final Rule is the prohibition on provisions limiting the liability (or indemnification) of an adviser using a standard above negligence. Certain prohibited activities in the Proposed Rule were also revised to permit such activities with adequate disclosure and consent. 

What’s on the Horizon?

The Final Rule will become effective 60 days post-publication in the Federal Register. Compliance dates vary, with some, like the Private Fund Audit Rule, having a timeline of 18 months after publication. During the Open Meeting at which the commissioners voted on the Final Rule, the SEC staff (“Staff”) indicated that the SEC Release (which is over 650 pages long) would contain guidance regarding the new provisions, as well guidance concerning the Staff’s interpretation of existing requirements under the Advisers Act.

The SEC is also considering different compliance dates for advisers based on their private fund assets under management.

Final Thoughts

The SEC's move underscores the significant role private funds and their advisers play in the financial ecosystem. As private fund assets under management continue to grow, the need for transparency, fairness, and stringent compliance has never been clearer.

This update is an initial overview of the Final Rule, so please stay tuned for a deeper dive into the rule and its implications in the coming days.