The U.S. Securities and Exchange Commission (SEC) has adopted new rules and amendments under the Investment Advisers Act of 1940, targeting private fund advisers. Although the initially proposed rules of February 2022 underwent significant modifications, they still present a comprehensive framework that private fund advisers.
New Directives for All Private Fund Advisers
Preferential Treatment Rule: This rule seeks transparency in the side letter process. Any preferential treatment given to specific investors will now be under the regulatory microscope, mandating disclosures and setting out prohibitions that reshape the side letter landscape.
Notice Rules: Advisers are now under obligation to inform prospective investors about any preferential terms that current investors enjoy. Moreover, if the adviser or its related individuals offer preferential treatment to certain investors, all existing investors need to be informed. The timeline for this disclosure varies based on the liquidity of the funds.
Prohibition on Certain Preferential Terms: Two types of preferential treatments are particularly prohibited under the new regulations:
- Advisers can’t offer redemption rights that might negatively impact other investors, barring some exceptions.
- Granting specific preferential information rights about portfolio assets is also restricted if it's expected to have a material adverse effect on other investors.
Restricted Activities Rule: Highlighting potential conflicts of interest, certain activities by private fund advisers are now strictly off the table. These encompass various disclosure requirements relating to clawbacks, regulatory fees, and fee allocations, as well as borrowing restrictions and sanctions-related fee prohibitions.
Compliance Date: The transition period for compliance depends on the amount of assets under management. Furthermore, the SEC has provided leniency for pre-existing private funds concerning certain prohibitions and activities requiring investor consent.
Specific Rules for RIAs
Apart from the aforementioned rules, RIAs have additional regulations:
Quarterly Statement Rule: RIAs are required to offer detailed quarterly statements to all investors, including comprehensive fee, expense, and performance disclosures.
Mandatory Audits: Each private fund managed by an RIA needs to undergo an annual financial audit.
Recordkeeping and Compliance Rule Amendments: Ensuring thorough compliance, RIAs must possess written records of their annual compliance policies and procedures reviews.
Adviser-Led Secondaries Rule: RIAs, prior to any secondary transaction led by them, must obtain a third-party fairness or valuation opinion and disclose significant business ties, if any, with the opinion provider.
The SEC's new framework under the Investment Advisers Act of 1940 is transformative for the private fund industry. The emphasis is clearly promoting transparency, ensuring fairness, and safeguarding investor interests.
Private fund advisers, irrespective of their RIA status, now have a rigorous set of directives to comply with. These encompass preferential treatments, fee charges, and specific restricted activities. For RIAs, the mandates are even more stringent with requirements for regular disclosures, audits, record-keeping, and fairness opinions.
The transition periods vary, providing some flexibility based on the size of the adviser's assets under management. Nevertheless, these new rules signify the SEC's intent to ensure a more transparent, fair, and accountable private fund industry.