US SEC adopts final version of its Private Fund Adviser Rules

On 23 August 2023, the SEC adopted the Private Fund Advisers Rules (the “Rules”), a series of rules and amendments under the Investment Advisers Act of 1940. This is effectively the final version of the proposed rule changes to enhance investor protection first announced in February 2022. Although a significant number of amendments have been made in the intervening 18 months, including softening of some proposals in response to industry concerns, the Rules collectively amount to a very considerable overhaul of the regulatory regime for private fund advisers.

Of particular interest to UK and EU managers are the Rules that apply to both Registered Investment Advisers (“RIA”) and Exempt Reporting Advisers (“ERA”). In summary, the Rules include:

• Restricted activities rules (RIAs and ERAs)
• Preferential treatment rules (RIAs and ERAs)
• Adviser-led secondaries rules (RIAs only)
• Quarterly reporting and audits (RIAs only)
• Written documentation of compliance program (RIAs only)

New exemption: the SEC publication also clarified that advisers of securitised asset funds are exempt from the Rules. Securitised asset funds are defined as “any private fund whose primary purpose is to issue asset-backed securities and whose investors are primarily debt holders”.

What will change for RIAs and ERAs?

1. Restricted Activities: All advisers (both RIAs and ERAs) will be prohibited from charging private fund clients for the following activities (except when stated conditions are met):

• Regulatory, compliance, and examination expenses – unless the adviser discloses in writing to investors the expenses (including amounts) within 45 days of the end of the relevant quarter;
• Clawbacks for taxes – unless the adviser discloses in writing to investors the pre- and post-tax clawback amounts within 45 days of the end of the relevant quarter;
• Allocation of fees and expenses on a non-pro rata basis – unless the allocation is a) “fair and equitable under the circumstances and b) written notice has been distributed in advance including a description of how condition a) is met;
• Investigation expenses (resulting from a government or regulatory agency) – unless the adviser requests consent from each investor and receives written consent from a majority of investors. If the adviser is ultimately sanctioned, any such charges are prohibited (regardless of majority consent); and
• Borrowing, or receiving a loan or extension of credit from a private fund client – unless material terms are disclosed, and written consent is obtained from a majority of investors.

2. Preferential Treatment: all advisers are prohibited from providing preferential treatment to one or more individual investors in respect of the following:

• Redemptions, if the adviser reasonably expects the terms to have a material, negative effect on other investors – unless a) the same redemption rights are offered to all other investors or b) the ability to redeem is required by applicable laws;
• Transparency, such as information on portfolio holdings or exposures, if the adviser reasonably expects that providing the information would have a material, negative effect on other investors – unless the same transparency is offered to all investors; and
• Other preferential terms, such as material economic terms – must be disclosed to all new and prospective investors.

(Please note that the above restrictions on preferential treatment will also apply to a “similar pool of assets”.)

3. Disclosures of preferential treatment to current investors: all advisers must provide an annual disclosure of preferential treatment to all investors and must also provide written notice of any new preferential treatment provided as soon as reasonably practicable at the end of the fundraising period.

4. Adviser-led secondaries: the SEC defines adviser-led secondary transactions as “transactions initiated by the investment adviser or any of its related persons that offer the private fund’s investors the choice between: (i) selling all or a portion of their interests in the private fund and (ii) converting or exchanging all or a portion of their interests in the private fund for interests in another vehicle advised by the adviser or any of its related persons.”

Advisers will be required to obtain either a fairness opinion or a valuation opinion on the secondary from an independent provider which is distributed to investors prior to the election form due date. They will be required to support the independent nature of this opinion by providing to investors a summary of any material business relationships with the opinion provider in the past two years.

5. Quarterly reporting: RIAs will be required to provide investors with quarterly statements (including disclosures on fees, expenses and fund performance) within 45 days of each quarter-end (75 days for fund of funds) and within 90 days of the end of the financial year (120 days for fund of funds).

6. Audits: RIAs will be required to obtain an annual financial statement audit of the private funds that they advise (either directly or indirectly). The SEC believes this provides an important check on the adviser’s valuation of assets, which in turn typically serve as the basis for the calculation of adviser fees.

7. Written documentation of compliance program: RIAs will be required to document the annual review of their compliance policies and procedures in writing. In essence, this means that advisers must periodically evaluate the effectiveness of their compliance programs and consider whether any improvements are needed. As the SEC notes, their own examination staff rely significantly on such documentation to help them understand the compliance program, assess compliance with applicable rules and identify any potential weaknesses. Of all the rule amendments, this is the one least likely to add significant costs but is also the first to come into force (13 November 2023).

When do these new rules come into effect?

Some Rules vary in their effective dates for larger and smaller advisers based on AUM of greater or less than $1.5 billion (calculated as at the last day of the adviser’s most recently completed fiscal year). The effective dates for the Final Rules are derived from their publication in the Federal Register on 14 September 2023, are as follows:

• Written documentation of compliance program: 13 November 2023
• Restricted activities, adviser-led secondaries and preferential treatment: Larger firms: 14 September 2024. Smaller firms: 14 March 2025
• Quarterly reporting and audits – 14 March

Next steps

There are a lot of new steps and rules for firms to digest, however RIAs will want to prioritise the new reporting requirements given the relatively short lead times. Next RIAs and (where relevant) ERAs should set about updating their policies and procedures to take account of the new restrictions.

Cosegic has in-house SEC expertise and we are here to assist with the implementation of both sets of requirements.

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