Are You Ready for the New SEC Private Fund Adviser Regulation?

By Michael A. Provini, Partner; Anna de Venoge, Supervisor; and Samveg Punamiya, Manager

The Securities and Exchange Commission (the SEC), Office of the Investor Advocate, submits two reports to Congress each year. One of them is the SEC’s fiscal year 2023 Report on Objectives. The key area of focus is private fund adviser regulation. Based on the SEC’s extensive experience overseeing private fund advisers, the SEC adopted new rules to address the identified risks to investors and funds, while promoting efficiency, competition and capital formation.

These rules came into effect on November 13, 2023. The timing of implementation of the rules varies from 60 days to 12 to 18 months. [See the SEC link for a table of required compliance dates for the rules.]

As noted by the SEC, investment advisers’ private fund assets under management have steadily increased over the past decade, growing from $9.8 trillion in 2012 to $26.6 trillion in 2022. Similarly, the number of private funds has risen from 31,717 in 2012 to 100,947 in 2022. Private funds and their advisers play an essential role in our financial markets and the lives of everyday Americans. This is a rulemaking of significant magnitude and will have far-reaching consequences. As SEC Chair Gensler has noted, “Private fund advisers, through the funds they manage, touch so much of our economy. Thus, it’s worth asking whether we can promote more efficiency, competition, and transparency in this field.” 

Specifically, the gravitas of some of the new rules and amendments follow.

Quarterly Statements Rule

The rule requires an investment adviser that is registered or required to be registered with the SEC to prepare a quarterly statement that includes certain information regarding fees, expenses and performance for any private fund that it advises and to distribute the quarterly statement to the private fund’s investors, unless a quarterly statement that complies with the rule is prepared and distributed by another person.

If the private fund is not a fund of funds, then a quarterly statement must be distributed within 45 days after the end of each of the first three fiscal quarters of each fiscal year and 90 days after the end of each fiscal year. If the private fund is a fund of funds, then a quarterly statement must be distributed within 75 days after the first, second and third fiscal quarter ends and 120 days after the end of the fiscal year of the private fund. The SEC details six areas required to comply with this portion of the rule.

Mandatory Private Fund Adviser Audits Rule 

The rule requires registered private fund advisers to cause the private funds they advise to undergo a financial statement audit at least annually and upon liquidation. The rule requires the audited financial statements to be distributed to investors promptly after the completion of the audit. These audits provide an important check on the adviser’s valuation of private fund assets, which often serve as the basis for calculating the adviser’s fees, and protect private fund investors against misappropriation of fund assets.

The SEC discusses eight areas under the rule, from requirements for accountants performing private fund audits to record-keeping provisions related to the audit rule.

Adviser-Led Secondaries Rule

The rule requires a registered private fund adviser to obtain a fairness opinion or valuation opinion in connection with an adviser-led secondary transaction. In these transactions, advisers often offer existing fund investors the option to sell or exchange their interests in the private fund for interests in another vehicle advised by the adviser. An independent opinion provider would opine on the fairness of the price being offered to the private fund for any assets being sold as part of the transaction. The rule also requires the adviser to prepare and distribute to the private fund investors a summary of any material business relationships the independent opinion provider has or has had within the past two years with the adviser or any of its related persons. This requirement provides a check against an adviser’s conflicts of interest in structuring and leading a transaction from which it may stand to profit at the expense of private fund investors.

Restricted Activities Rule 

The rule prohibits all private fund advisers from engaging in certain activities and practices that tend to create conflicts of interest that could reasonably lead to fraud and investor harm because such practices incentivize an adviser to place its interests ahead of the private fund’s interests. Some of these practices include:

  • Charging certain fees and expenses to a private fund or its portfolio investments, such as fees for unperformed services (e.g., accelerated monitoring fees) and fees associated with an examination or investigation of the adviser.
  • Seeking reimbursement, indemnification, exculpation, or limitation of its liability for certain activity.
  • Reducing the amount of an adviser clawback by the amount of certain taxes.
  • Charging fees or expenses related to a portfolio investment on a non-pro-rata basis.
  • Borrowing or receiving an extension of credit from a private fund client.

Certain Adviser Misconduct Rule

The SEC found it unnecessary for the final rule to prohibit an adviser from charging fees without providing a corresponding service to its private fund client because such activity is already inconsistent with the adviser’s fiduciary duty.

The SEC also reminds advisers of their obligation to act consistently with their federal fiduciary duty and their legal obligations under the Advisers Act, including the antifraud provisions. A waiver of an adviser’s compliance with its federal antifraud liability for breach of its fiduciary duty to the private fund or otherwise, or of any other provision of the Advisers Act, or rules thereunder, is invalid under the Act. An adviser’s federal fiduciary duty is to its clients, and the obligations that flow from the adviser’s fiduciary duty depend upon what functions the adviser, as agent, has agreed to assume for the client, its principal.

Preferential Treatment Rule

The rule prohibits all private fund advisers from providing preferential terms to certain investors regarding redemptions from the fund or information about portfolio holdings or exposures. It also prohibits all private fund advisers from providing other preferential treatment unless disclosed to current and prospective investors. This is designed to protect investors by prohibiting specific types of preferential treatment that have a material, negative effect on other investors.

The Complete Rules

The rules are over 600 pages long, and there are many additional areas that need to be considered when managing your business.

Contact Us

We at PKF O’Connor Davies are available to review these new rules that could provide unintended consequences for your business if not properly planned to adopt, such as the imposition of substantial compliance costs and the difficulty of attracting subsequent capital infusions into your funds.

To help you navigate these changes, please reach out to your PKF O’Connor Davies client service team or any of the following:

Michael A. Provini, CPA
Partner | 646.449.6330

Anna de Venoge
Supervisor | 646.699.2916

Samveg Punamiya
Manager | 914.421.5689