Introduction

On August 23, 2023, a divided Securities and Exchange Commission (SEC) adopted far-reaching new rules and rule amendments under the Investment Advisers Act of 1940, as amended (Advisers Act). While the final rules are not as burdensome as the versions initially proposed, the SEC nevertheless adopted many of the proposed rules and amendments or modified versions of the proposed rules and amendments, including rules and amendments related to restricted activities, preferential treatment, quarterly statements, audits, and adviser-led secondary transactions (Private Fund Adviser Rules). The SEC also adopted amendments to Advisers Act Rule 206(4)-7 (Compliance Rule) that require all advisers registered with the SEC, regardless of whether they advise private funds, to maintain written documentation of their annual compliance reviews (the amendments to the Compliance Rule, together with the Private Fund Adviser Rules, hereinafter referred to as the New Rules).

During the SEC’s open meeting to consider adopting the New Rules, the Staff of the Division of Investment Management highlighted the following seven key changes from the proposal:

1. The scope of the New Rules was revised to provide that the Private Fund Adviser Rules do not apply to securitized asset funds (such as collateralized loan obligations (CLOs));
2. The proposed Quarterly Statement Rule was revised to limit reporting to a 10-year period for liquid funds and to allow additional time for delivering certain quarterly statements;
3. The Adviser-Led Secondaries Rule was revised to allow advisers to choose between providing a fairness opinion or a valuation opinion;
4. The proposed Prohibited Activities Rule was replaced by the Restricted Activities Rule, which does not flatly prohibit all of the contemplated activities and instead allows advisers to engage in certain activities with appropriate disclosures and, in certain circumstances, consents (although, as detailed below, one activity remains prohibited);
5. The Restricted Activities Rule no longer contains a prohibition against limitations of liability, indemnification or exculpation clauses, or collecting fees for unperformed services, as the SEC took the position that these practices are already regulated by the Advisers Act;
6. Private fund advisers will not be required to repaper existing fund governance documents that are in place for private funds that commenced operations prior to the compliance date of the Restricted Activities Rule and Preferential Treatment Rule and that would otherwise need to be amended as a result of such rules; and
7. Certain of the New Rules have staggered compliance dates based on the amount of private fund assets managed by the adviser.

During the open meeting, the Commissioners spent a considerable amount of time discussing the SEC’s authority to adopt the Private Fund Adviser Rules, with certain Commissioners questioning the basis for the SEC’s authority that was outlined in the adopting release. The prominence of this topic during the open meeting and in the adopting release comes as no surprise. Many of the commenters on the proposed rules challenged the SEC’s authority to adopt the Private Fund Adviser Rules, and certain industry groups threatened to file suit against the SEC in the event the rules were adopted. As anticipated, on September 1, 2023, six industry groups, including the Managed Funds Association, filed a petition for review of the New Rules in the United States Court of Appeals for the Fifth Circuit.¹

Scope

The Private Fund Adviser Rules substantively regulate several aspects of an adviser’s relationship with a private fund and its investors that have historically been left to the marketplace and to the negotiating process between a private fund adviser and its investors. While some of the New Rules affect only registered investment advisers, others would affect exempt reporting advisers, state-registered investment advisers and unregistered investment advisers. In the adopting release, the SEC clarified the scope of the New Rules, noting that none of the Private Fund Adviser Rules would apply to advisers of securitized asset funds² (such as CLOs), solely with respect to such funds. Further, the SEC clarified that none of the New Rules would apply with respect to the offshore fund clients of SEC-registered or unregistered offshore advisers (in all cases, regardless of whether those offshore funds have US investors). While the Private Fund Adviser Rules affect only advisers that advise private funds,³ the amendments to the Compliance Rule apply to all SEC-registered advisers, regardless of whether they advise private funds.

The chart below identifies the scope of advisers that are affected with respect to each New Rule:

† Excludes any SEC-registered offshore adviser with respect to its offshore clients. An SEC-registered offshore adviser may manage accounts of US clients and accounts of non-US clients in a single unified business. As such, in practice many SEC-registered offshore advisers will be impacted by the amendments to the Compliance Rule even with respect to accounts of their non-US clients.
* Excludes advisers of securitized asset funds (such as CLOs), solely with respect to the securitized asset funds that they advise.
^ Excludes any SEC-registered offshore adviser with respect to its offshore fund clients (regardless of whether those funds have US investors).
⁺ Excludes any offshore unregistered advisers with respect to its offshore fund clients (regardless of whether those funds have US investors).

Discussion

1. Restricted activities

As proposed, new Advisers Act Rule 211(h)(2)-1 was called the ”Prohibited Activities Rule” and would have prohibited advisers from engaging in certain enumerated activities. Upon adoption, however, the SEC narrowed the scope of prohibited activities and adopted a less expansive rule that generally restricts certain practices, unless the adviser satisfies certain disclosure and, in some cases, consent requirements (Restricted Activities Rule). Under the Restricted Activities Rule, an adviser to a private fund may not directly or indirectly with respect to the private fund or any investor in that private fund:

1. charge or allocate to the private fund fees or expenses associated with an investigation of the adviser or its related persons⁴ by a governmental or regulatory authority, unless the adviser requests each investor of the private fund to consent⁵ to, and obtains written consent from, at least a majority in interest of the private fund’s investors that are not related persons of the adviser for such charge or allocation, provided, however, that the adviser is flatly prohibited from charging or allocating to the private fund fees or expenses associated with an investigation that results or has resulted in a court or governmental authority imposing a sanction for a violation of the Advisers Act or the rules thereunder;⁶
2. charge or allocate to the private fund any regulatory or compliance fees or expenses, or fees or expenses associated with an examination of the adviser or its related persons, unless the adviser distributes a written notice of any such fees or expenses, and the dollar amount thereof, to the investors of such private fund client in writing within 45 days after the end of the fiscal quarter in which the charges occur;
3. reduce the amount of an adviser clawback⁷ by actual, potential or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders, unless the adviser distributes a written notice to the investors of such private fund client that sets forth the aggregate dollar amounts of the adviser clawback before and after any reduction for actual, potential or hypothetical taxes within 45 days after the end of the fiscal quarter in which the adviser clawback occurs;
4. charge or allocate fees or expenses related to a portfolio investment (or potential portfolio investment) on a non-pro rata basis when multiple private funds and other clients advised by the adviser or its related persons have invested (or propose to invest) in the same portfolio investment, unless (i) the non-pro rata charge or allocation is fair and equitable under the circumstances and (ii) prior to charging or allocating such fees or expenses to a private fund client, the adviser distributes to each investor of the private fund a written notice of the non-pro rata charge or allocation and a description of how it is fair and equitable under the circumstances; or
5. borrow money, securities or other private fund assets, or receive a loan or an extension of credit, from a private fund client, unless the adviser (i) distributes to each investor a written description of the material terms of, and requests each investor to consent to, such borrowing, loan or extension of credit; and (ii) obtains written consent from at least a majority in interest of the private fund’s investors that are not related persons of the adviser.

The Restricted Activities Rule contains a grandfathering provision that states the disclosure/consent requirements associated with 1 and 5 above do not apply to contractual agreements governing a private fund (or agreements governing a borrowing, loan or extension of credit entered into by a private fund) that has commenced operations⁸ as of the compliance date of the Restricted Activities Rule if such contractual agreements would need to be amended to comply with these provisions of the Restricted Activities Rule. The Restricted Activities Rule specifically states, however, that the grandfathering provision does not permit an adviser to a private fund to charge or allocate to the private fund fees or expenses related to an investigation that results or has resulted in a court or governmental authority imposing a sanction for a violation of the Advisers Act or the rules promulgated thereunder.

The SEC adopted companion amendments to Advisers Act Rule 204-2 (Books and Records Rule) in connection with the Restricted Activities Rule that require advisers to retain copies of all written notifications, consents or other documents distributed or received pursuant to the Restricted Activities Rule, along with a record of each addressee and the corresponding date(s) such documents were distributed by the adviser.⁹

The SEC did not adopt the proposed prohibition on charging a portfolio investment for monitoring, servicing, consulting or other fees in respect of any services that the adviser does not, or does not reasonably expect to, provide to the portfolio investment, stating that such activities were already inconsistent with the adviser’s fiduciary duty and thus were not necessary to state in the final Restricted Activities Rule.

The SEC also did not adopt the proposed prohibition on an adviser seeking reimbursement, indemnification, exculpation or limitation of its liability by the private fund or its investors for a breach of fiduciary duty, willful misfeasance, bad faith, negligence or recklessness in providing services to the private fund. While the Restricted Activities Rule does not contain such a provision, the adopting release reiterated the SEC’s position that a waiver of an adviser’s federal antifraud liability for breach of its fiduciary duty to the private fund or of any other provision of the Advisers Act (or the rules thereunder) is invalid. Whether a contractual clause purporting to limit an adviser’s liability (also known as hedge clauses or waiver clauses) in an agreement with a private fund would violate the Advisers Act’s antifraud provisions will be determined based on the particular facts and circumstances. The SEC did note, however, that an adviser violates the antifraud provisions of the Advisers Act if there is a contract provision waiving any and all of its fiduciary duties (or the adviser’s federal fiduciary duty) and there is no language clarifying that the adviser is not waiving its federal fiduciary duty or that the client retains certain non-waivable rights. Finally, an adviser may not seek reimbursement, indemnification or exculpation for breaching its federal fiduciary duty (because such reimbursement, indemnification or exculpation would operate effectively as a waiver, which would be invalid under the Advisers Act).

2. Preferential treatment

New Advisers Act Rule 211(h)(2)-3 (Preferential Treatment Rule) restricts advisers from engaging in certain practices with respect to a private fund that favor certain investors over others, except under certain circumstances as described below. The version of the Preferential Treatment Rule that was adopted is substantially similar to the version that was proposed, and thus represents a profound shift from current practice in the private fund industry.

The Preferential Treatment Rule, like the Restricted Activities Rule, contains a grandfathering provision that states certain provisions of the Preferential Treatment Rule (specifically those described in subsections A. Preferential redemptions and B. Preferential transparency below) shall not apply to contractual agreements governing a private fund that has commenced operations as of the compliance date of the Preferential Treatment Rule and that were entered into in writing prior to the compliance date if compliance with such rules would require the parties to amend such governing agreements.

1. Preferential redemptions

The Preferential Treatment Rule prohibits an adviser and its related persons from granting an investor in the private fund or in a similar pool of assets the ability to redeem its interest on terms that the adviser reasonably expects to have a material, negative effect on other investors in that private fund or in a similar pool of assets¹⁰ except (i) if such ability to redeem is required by applicable laws, rules or regulations that the investor, private fund or similar pool of assets is subject to or (ii) if the adviser has offered the same redemption ability to all other existing investors, and will continue to offer such redemption ability to all future investors, in the private fund or in any similar pool of assets.

2. Preferential transparency

The Preferential Treatment Rule also prohibits an adviser and its related persons from providing information regarding the portfolio holdings or exposures of the private fund or of a similar pool of assets to any investor in the private fund if the adviser reasonably expects that providing the information would have a material, negative effect on other investors in that private fund or in a similar pool of assets, except if the adviser offers such information to all other existing investors in the private fund or in any similar pool of assets at the same time or substantially the same time.

3. Notice requirements

The Preferential Treatment Rule also prohibits any preferential terms unless the adviser provides certain written disclosures to prospective and current investors as follows:

• advance written notice to prospective investors: the adviser must provide to each prospective investor in the private fund, prior to the investor’s investment in the private fund, a written notice that provides specific information regarding any preferential treatment related to any material economic terms that the adviser or its related persons provide to other investors in the same private fund.¹¹
• written notice for current investors in a private fund:
  • the adviser must distribute to current investors in an illiquid fund, as soon as reasonably practicable following the end of the private fund’s fundraising period, written disclosure of all preferential treatment the adviser or its related persons have provided to other investors in the same private fund;
  • the adviser must distribute to current investors in a liquid fund, as soon as reasonably practicable following the investor’s investment in the private fund, written disclosure of all preferential treatment the adviser or its related persons have provided to other investors in the same private fund; and
  • the adviser must distribute, on at least an annual basis (regardless of whether the fund is illiquid or liquid), a written notice that provides specific information regarding any preferential treatment provided by the adviser or its related persons to other investors in the same private fund since the last written notice provided in accordance with the rule, if any.

The notice requirements also apply to preferential redemptions and preferential transparency described above, in addition to any other preferential treatment. The grandfathering provision of the Preferential Treatment Rule does not apply to the notice requirements.

4. Recordkeeping requirements for preferential treatment

The SEC adopted companion amendments to the Books and Records Rule in connection with the Preferential Treatment Rule that require advisers to retain copies of all written notices sent to current and prospective investors in a private fund. In addition, advisers are required to retain copies of a record of each addressee and the corresponding date(s) the notices were sent.

3. Quarterly statements

New Advisers Act Rule 211(h)(1)-2 (Quarterly Statement Rule) requires any adviser to one or more private funds that is registered or required to be registered with the SEC (each, a registered private fund adviser) to prepare a quarterly statement that includes certain information regarding fees, expenses and performance for any private fund that it advises.

1. Fee and expense disclosure

The Quarterly Statement Rule requires registered private fund advisers to present information in quarterly statements in a standardized tabular format. In particular, a registered private fund adviser is required to disclose:

• a detailed accounting of all compensation, fees and other amounts allocated or paid to the adviser or any of its related persons by the private fund during the reporting period (adviser compensation);
• a detailed accounting of all fees and expenses allocated to or paid by the private fund during the reporting period other than adviser compensation, including, but not limited to, organizational, accounting, legal, administration, audit, tax, due diligence and travel expenses (fund expenses); and
• the amount of any offsets or rebates carried forward during the reporting period to subsequent quarterly periods to reduce future payments or allocations to the adviser or its related persons.

To the extent that a given fund expense could be characterized as adviser compensation under the Quarterly Statement Rule, the Quarterly Statement Rule requires a registered private fund adviser to disclose the payment or allocation as adviser compensation and not as a fund expense in the quarterly statement.

In addition to adviser compensation, fund expenses and rebates, registered private fund advisers are required to provide a detailed accounting of all portfolio investment compensation allocated or paid to the registered private fund adviser or any of its related persons by a covered portfolio investment during the reporting period (covered portfolio investment requirement). This information must be presented with separate line items for each category of allocation or payment, reflecting the total dollar amount, presented both before and after the application of any offsets, rebates or waivers.

The Quarterly Statement Rule defines the following terms related to the covered portfolio investment requirement:

• portfolio investment means any entity or issuer in which the private fund has invested directly or indirectly. This would encompass investments through holding companies, subsidiaries, acquisition vehicles, special-purpose vehicles and other vehicles. It also encompasses nontraditional investments, such as music royalties, aircraft and tanker vessels. However, the SEC does not treat an investment in a derivative as an investment in the derivative’s counterparty.
• portfolio investment compensation means any compensation, fees and other amounts allocated or paid to the adviser or any of its related persons by the portfolio investment attributable to the private fund’s interest in such portfolio investment, including, but not limited to, fees or payments related to origination, management, consulting, monitoring, servicing, transaction, administrative, advisory, closing, disposition, directors, trustees, or similar fees or payments.
• covered portfolio investment means a portfolio investment that allocated or paid the adviser or its related persons portfolio investment compensation during the reporting period. In short, if the adviser does not receive portfolio investment compensation from a particular portfolio investment, the Quarterly Statement Rule does not require it to list any information regarding that portfolio investment for the applicable reporting period.

The Quarterly Statement Rule also requires each statement to include prominent disclosure regarding how the adviser calculates expenses, payments, allocations, rebates, waivers and offsets. The quarterly statement also is required to include cross-references to the relevant sections of the private fund’s organizational and offering documents that set forth the calculation methodology.

In a departure from the proposal, the SEC eliminated the proposed requirement to disclose the private fund’s ownership percentage of each covered portfolio investment as of the end of the reporting period.

2. Performance disclosure

The Quarterly Statement Rule establishes performance reporting requirements for private funds, which differ depending on whether a private fund is a liquid fund or an illiquid fund. Many commenters on the proposal criticized the illiquid/liquid fund distinction, while others supported it. Ultimately, the SEC retained the distinction in the final rule but adopted a less technical and more targeted definition of illiquid fund. In the final rule, illiquid fund is defined as a private fund that is not required to redeem interests upon an investor’s request and has limited opportunities, if any, for investors to withdraw before termination of the private fund. A liquid fund is defined as any private fund that is not an illiquid fund. The SEC states that liquid funds generally allow periodic investor redemptions (whether monthly, quarterly or semiannually) and primarily invest in market-traded securities and therefore determine their net asset value regularly.

The Quarterly Statement Rule requires an adviser to a liquid fund to show performance based on net total return on an annual basis, over prescribed time periods and on a quarterly basis for the current year. Specifically, an adviser to a liquid fund is required to disclose the liquid fund’s:

• annual net total returns for each fiscal year over the past 10 fiscal years, or since inception, whichever time period is shorter;
• average annual net total returns over the one-, five- and ten-fiscal-year periods (if available); and
• cumulative net total return for the current fiscal year as of the end of the most recent fiscal quarter covered by the quarterly statement.

For illiquid funds, the Quarterly Statement Rule requires an adviser to show performance based on the internal rate of return and a multiple of invested capital, on both a net and a gross basis.¹² Specifically, advisers to illiquid funds are required to disclose the following performance measures in the quarterly statement, shown since inception of the illiquid fund through the end of the quarter covered by the quarterly statement,¹³ and computed with and without the impact of any fund-level subscription facilities:¹⁴

• gross internal rate of return¹⁵ and gross multiple of invested capital¹⁶ for the illiquid fund;
• net internal rate of return and net multiple of invested capital for the illiquid fund; and
• gross internal rate of return and gross multiple of invested capital for the realized and unrealized portions of the illiquid fund’s portfolio, with the realized and unrealized performance shown separately.

A quarterly statement that complies with the performance disclosure requirements of the Quarterly Statement Rule, contains no other information and is sent only to existing private fund investors generally will not be an “advertisement” under Advisers Act Rule 206-4(1) (Marketing Rule). However, if a quarterly statement also is an “advertisement,” under the Marketing Rule, the internal rate of return and multiple of invested capital for the realized and unrealized portions of an illiquid fund’s portfolio must comply with the extracted performance and net performance requirements of the Marketing Rule.¹⁷

The Quarterly Statement Rule requires advisers to display the different categories of required performance information with equal prominence. Additionally, advisers are required to provide investors with a statement of contributions and distributions for an illiquid fund.¹⁸ 

The Quarterly Statement Rule requires registered private fund advisers to include prominent disclosure of the criteria used and assumptions made in calculating private fund performance. This disclosure must be included within the quarterly statement and may not be provided in a separate document, website hyperlink or QR code, or other separate disclosure.

The SEC continues to maintain that one goal of the Quarterly Statement Rule is to improve comparability among private funds with similar characteristics. However, the SEC did not propose or adopt specific methodologies to compute net total return or internal rate of return, and it acknowledged that methodologies used by private funds to determine realization can vary considerably.

3. Preparation and distribution of quarterly statements

In response to concerns from commenters, the Quarterly Statement Rule, as adopted, differentiates between “funds of funds” and all other private funds with respect to the timing of quarterly statement distribution. The Quarterly Statement Rule requires quarterly statements to be prepared and distributed to investors in private funds that are not funds of funds within 45 days after the first three fiscal quarter ends of each fiscal year and 90 days after the end of each fiscal year. Advisers to funds of funds must prepare and distribute quarterly statements within 75 days after the first three fiscal quarter ends of each year and 120 days after the fiscal year-end. For a newly formed private fund, the Quarterly Statement Rule requires registered private fund advisers to prepare and distribute a quarterly statement after the private fund has two full calendar quarters of operating results and continuously each calendar quarter thereafter.

4. Consolidated reporting for certain fund structures

The Quarterly Statement Rule requires registered private fund advisers to consolidate reporting for similar pools of assets to the extent doing so would provide more meaningful information to the private fund’s investors and would not be misleading. This requires an adviser to a private fund that utilizes a master-feeder structure to provide feeder fund investors with a single quarterly statement covering the applicable feeder fund and the feeder fund’s proportionate interest in the master fund on a consolidated basis, so long as the consolidated statement would provide more meaningful information to investors and would not be misleading. Certain commenters requested more guidance regarding when consolidated reporting would be required; however, the SEC declined to make the rule more prescriptive, or provide guidance, and retained the proposed principles-based approach. In the proposal, the SEC requested comments regarding whether the Quarterly Statement Rule should require investor-specific or class-specific reporting in addition to fund-level reporting. In adopting the Quarterly Statement Rule, the SEC determined that such granular reporting was not essential to the rulemaking and did not require such detailed reporting.

5. Format and presentation standards

The Quarterly Statement Rule requires a registered private fund adviser to use clear, concise, plain English in its quarterly statement. Any information that an adviser chooses to include in a quarterly statement that is not required to be included, must be as short as practicable, not more prominent than the required information and not serve to obscure or impede an investor’s understanding of the mandatory information.¹⁹ In addition, the Quarterly Statement Rule requires an adviser to present information in the quarterly statement in a format that facilitates review from one quarterly statement to the next.

The format and content requirements apply to each element of a quarterly statement, including the requirement to disclose the manner in which expenses, payments, allocations, rebates, waivers and offsets are calculated and to cross-reference sections of the private fund’s organizational and offering documents.

6. Recordkeeping associated with quarterly statements

The SEC adopted certain companion amendments to the Books and Records Rule to require registered private fund advisers to retain books and records related to the Quarterly Statement Rule. These amendments require registered private fund advisers to:

• retain a copy of any quarterly statement distributed to fund investors, as well as a record of each addressee and the date(s) the statement was sent;
• retain all records evidencing the calculation method used for all expenses, payments, allocations, rebates, offsets, waivers and performance listed on any quarterly statement delivered; and
• make and keep books and records substantiating the adviser’s determination that the private fund it manages is a liquid fund or an illiquid fund.

4. Private fund adviser audits

New Advisers Act Rule 206(4)-10 (Audit Rule) requires registered private fund advisers to obtain an annual audit of the financial statements of the private funds they advise, directly or indirectly. The SEC adjusted the requirements of the Audit Rule from the proposal after commenters expressed concerns regarding the overlapping and inconsistent standards between the requirements of Rule 206(4)-2 under the Advisers Act (Custody Rule) and the proposed Audit Rule. To address these concerns, the version of the Audit Rule adopted by the SEC requires registered private fund advisers to cause their private funds to undergo audits in accordance with the audit provision (and related requirements) of the Custody Rule. Specifically, the Audit Rule, as adopted, sets forth the following requirements: 

• the audit must meet the definition of “audit” set forth in Rule 1-02(d) of Regulation S-X;
• the audit must be performed by an independent public accountant that meets the standards of independence in Rule 2-01(b) and (c) of Regulation S-X and that is registered with, and subject to regular inspection as of the commencement of the professional engagement period, and as of each calendar year-end, by, the Public Company Accounting Oversight Board;
• audited financial statements must be prepared in accordance with generally accepted accounting principles; and
• annually within 120 days of the private fund’s fiscal year-end and promptly upon liquidation, the private fund’s audited financial statements must be delivered to investors in the private fund.

Similar to the proposal, if an adviser does not control the private fund and is neither controlled by nor under common control with the fund, the Audit Rule requires the adviser to take all reasonable steps to cause its private fund client to undergo an audit that would satisfy the Audit Rule.

The SEC acknowledged in the adopting release that the Audit Rule effectively eliminates the surprise examination option under the Custody Rule for private fund advisers with respect to the private funds they manage.

The SEC adopted certain companion amendments to the Books and Records Rule that require an adviser to keep a copy of any audited financial statements, along with a record of each addressee and the corresponding date(s) the statements were sent. An adviser to a private fund that it is not in a control relationship with would be required to keep a record documenting the steps the adviser took to cause the private fund client to undergo a financial statement audit that would comply with the Audit Rule.

In a notable departure from the proposal, the final Audit Rule does not require an adviser to enter into, or cause the private fund to enter into, a written agreement with the independent public accountant performing the audit requiring it to notify the SEC (i) promptly upon issuing an audit report to the private fund that contains a modified opinion and (ii) within four business days of resignation or dismissal from, or other termination of, the engagement, or upon removing itself or being removed from consideration for being reappointed. The SEC removed this requirement in order to align the Audit Rule with the Custody Rule; however, in the adopting release the SEC noted it recently proposed amendments to the Custody Rule that, if adopted, would impose a similar notification provision to the one originally proposed as part of the Audit Rule.²⁰

5. Adviser-led secondaries

New Advisers Act Rule 211(h)(2)-2 (Adviser-Led Secondaries Rule) sets forth certain requirements in connection with an adviser-led secondary transaction, which is defined as any transaction initiated by the adviser or any of its related persons that offers private fund 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.

An adviser generally would be viewed as initiating an adviser-led secondary transaction if it commenced a process, or caused one or more other persons to commence a process, that was designed to offer private fund investors the option described above to obtain liquidity for their private fund interests. An adviser would not generally be viewed as initiating an adviser-led secondary transaction if the adviser, at the unsolicited request of the investor, assisted in the secondary sale of such investor’s fund interest or if the adviser conducted a tender offer for fund interests.

The Adviser-Led Secondaries Rule requires a registered private fund adviser, prior to the due date of the election form²¹ for the adviser-led secondary transaction, to (i) obtain and distribute a fairness opinion or valuation opinion from an independent opinion provider²² and (ii) prepare and distribute a written summary of any material business relationships the adviser or any of its related persons have, or have had within the two-year period immediately prior to the issuance of the fairness opinion or valuation opinion, with the independent opinion provider. 

A fairness opinion is a written opinion stating that the price being offered to the private fund for any assets being sold as part of an adviser-led secondary transaction is fair. A valuation opinion is a written opinion stating the value (as a single amount or a range) of any assets being sold as part of an adviser-led secondary transaction. Under the proposal, advisers did not have the option of obtaining and distributing a valuation opinion. Several commenters expressed concerns regarding the costs associated with obtaining a fairness opinion. In considering these comments, the SEC reiterated its belief that a third-party opinion was essential to address the conflicts of interest inherent in an adviser-led secondary transaction, but it acknowledged that a valuation opinion (which may cost less to prepare) also would be appropriate and would provide investors with a strong basis to make an informed decision regarding the adviser-led secondary transaction.

In connection with the Adviser-Led Secondaries Rule, the SEC adopted certain companion amendments to the Books and Records Rule that require registered private fund advisers to retain a copy of the fairness or valuation opinion and material business relationship summary distributed to investors, as well as a record of each addressee and the date(s) the opinion was sent.

6. Written documentation requirement for all registered investment advisers’ annual reviews of compliance programs

The amendments to the Compliance Rule were adopted as proposed and generally will require SEC-registered investment advisers (including those that do not manage any private funds) to document in writing the annual review of their compliance policies and procedures. The SEC states that it has found that some advisers do not make and preserve written documentation of the annual review of their compliance policies and procedures. According to the SEC, its examination staff relies on documentation of the annual review to help it understand an adviser’s compliance program, determine whether the adviser is complying with the Compliance Rule and identify potential weaknesses in the compliance program.

Consistent with the proposal, the new amendments do not enumerate particular elements that advisers must include in the written documentation of their annual review. The SEC stated that the written documentation requirement is intended to be flexible to allow advisers to continue to use the review procedures they have developed and found most effective.

7. Effective and compliance dates

The New Rules will take effect 60 days after publication in the Federal Register (Effective Date); however, the SEC’s interpretations regarding how an adviser’s fiduciary duty applies to its private fund clients (as discussed in the Restricted Activities Rule section above) are effective immediately.

Compliance with the Restricted Activities Rule, Preferential Treatment Rule and Adviser-Led Secondaries Rule will be required within 12 months of the Effective Date for advisers with $1.5 billion or more in private fund assets under management and within 18 months of the Effective Date for advisers with less than $1.5 billion in private fund assets under management.

Compliance with the Quarterly Statement Rule and Audit Rule will be required within 18 months after the Effective Date.

Compliance with the amendments to the Compliance Rule is required on the Effective Date.

Conclusion

While the final Private Fund Adviser Rules are not as burdensome as originally proposed, they still represent a seismic shift for the private fund industry, and many believe that the rules will have negative effects on investors in private funds. As stated in the Managed Fund Association’s press release relating to the petition for review, “[t]he Private Fund Adviser rule will harm investors, fund managers, and markets by increasing costs, undermining competition, and reducing investment opportunities for pensions, foundations, and endowments.” Even though the Private Fund Adviser Rules are being challenged in court, advisers should begin preparing their firms for the rules to take effect. Preparation for compliance with the Private Fund Adviser Rules will require extensive planning and cooperation from all departments of an investment adviser.

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1 Petition for Review, National Association of Private Fund Managers v. SEC, 5th Cir., No. 23-60471, filed September 1, 2023, available at https://www.managedfunds.org/wp-content/uploads/2023/09/MFA-Filing.pdf.

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