On August 23, 2023, the SEC adopted sweeping new rules governing private funds. These new rules and amendments are an effort to increase transparency, help protect private fund investors, and increase competition. In this article, we’ll summarize the rules and other information about these upcoming compliance changes.

Please note: This article is intended as general information only and is not intended as legal advice. As with all new rules and amendments, it is common to expect future clarifications that may impact how these regulations are applied. We recommend that you consult with your legal advisor for recommendations on ensuring your compliance going forward.

The compliance dates will vary based on the amount of private fund assets under management:

• Some rules will become effective on September 14, 2024, for private fund advisers with at least US$1.5 billion under management.

• The remaining rules take effect on March 14, 2025, for all private fund advisers.

However, these implementation dates may be impacted by the outcome of pending litigation.

Two new rules will impact all private fund advisors.

1. Restricted Activities Rule

This new requirement restricts certain activities unless a disclosure is made or, in some cases, unless investor consent is obtained. This rule requires that, unless fully disclosed, advisors may not:

• Charge investors for their compliance or regulatory fees or expenses.

• Claw back taxes from the funds.

• Charge or allocate portfolio-level fees or expenses on a non-pro-rata basis.

This rule also requires that the advisor may not do any of the following unless they obtain the consent of a majority of fund investors (excluding advisors’ and related person’s interests):

• Charge their clients for any fees or expenses associated with government or regulatory investigations.

• Borrow assets from their private fund clients.

2. Preferential Treatment Rule

The preferential treatment rule is the second new rule impacting all private fund advisors. As the name implies, this rule will prohibit certain types of special treatment that may negatively impact other investors unless disclosed to current and prospective investors. 

Generally, a fund adviser may not:

• Allow any preferential fund redemptions to one or more investors unless required by law or offered to all investors.

• Disclose information to an investor that may materially harm other investors (unless offered to all investors).

• Engage in any preferential treatment unless that activity is disclosed to all current and prospective investors.

In an effort to protect investors by increasing transparency, the SEC has set forth new guidelines that will provide more information to all private fund investors. These requirements are only applicable to SEC-registered advisors.

1. Quarterly Statements

This initiative aims to protect investors from hidden costs and surprise term changes that could negatively impact their investment. Private fund managers will be required to furnish investors with quarterly statements detailing fund performance, fees, expenses, and any potential conflicts of interest. The statements must also comply with requirements to disclose how individual line items are calculated.

In addition, the SEC also amended an existing rule (Rule 204-2), which will now require the retention of books and records used in preparing these quarterly statements.

2. Private Fund Audit Rule

This new rule dictates that private funds must undergo annual independent financial statement audits, with the results shared with investors. This move towards increased accountability and accuracy in reporting seeks to bolster investor confidence.

This rule, however, does not impose additional audit requirements beyond those already required by the Custody Rule. Auditors are also not required to report any issues found to the SEC.

3. Adviser-Led Secondary Rule

A fairness or valuation opinion will now be required for any adviser-led secondary transaction. The opinion needs to be provided by an independent firm, and the adviser needs to disclose any material relationship with the opinion provider over the last two years. This rule is designed to prevent fraud and help ensure accurate valuation.

4. Compliance Rule Amendment

All registered advisers, including those without private funds, must document their annual review of compliance policy and procedures in writing.

According to an AIMA article by Karen Anderberg of Laurel Neale, Dechert LLP, these rules will have limited impact on fund managers whose primary office and place of business are located outside the United States. However, this is likely to be clarified over time. More information can be found in this article.

The SEC’s new private fund rules mark a substantial shift in how private funds will operate and interact with investors. While this adds to the complexity of fund management, it also creates an opportunity for fund managers to increase their competitiveness and enhance their value proposition to investors.

Increasing efficiency is critical to staying compliant while keeping agile in this new reality of increased regulatory requirements. Linnovate Partners offers fund managers an integrated suite of advanced technology and services to help ease the burden of compliance while allowing your team fast access to the data that enables you to stay focused on your mission. 

Schedule a complimentary consultation today to find out.