On August 23, 2023, the Securities and Exchange Commission (SEC) adopted a final rule package (each a Rule, and together, the Rules) that modifies the regulation of private fund advisers under the US Investment Advisers Act of 1940, as amended (the Advisers Act). See a table summarizing the key provisions of the Rules here.

Among other things, the Rules require that all SEC-registeredReferences to a “registered” private fund adviser herein also refers to private fund advisers required to be registered with the SEC. private fund“Private funds” are privately offered investment vehicles that pool capital from one or more investors and invest in securities and other instruments or investments. Section 202(a)(29) of the Advisers Act defines the term “private fund” as an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, as amended, but for section 3(c)(1) or 3(c)(7) of that Act. Securitized asset funds, as defined below, are generally excluded from the term “private funds.” advisers:

• prepare and distribute quarterly statements to investors containing detailed information on fees, expenses, compensation, and performance;
• obtain and distribute to investors an annual audit for each private fund such advisers manage (using the same standards applied to annual private fund audits under Rule 206(4)-2 under the Advisers Act (the Custody Rule)); and
• obtain and distribute to investors a fairness or valuation opinion from an independent opinion provider in connection with an adviser-ledAdviser-led secondary transaction means any transaction initiated by the investment adviser or any of its related persons that offers private fund investors the choice between: (1) Selling all or a portion of their interests in the private fund; and (2) 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. secondary transaction, as well as distribute to such investors a written summary of any key relationships with the independent opinion provider.

Additionally, the Rules place restrictions on certain activities by all private fund advisers (including exempt reporting advisers), including:

• charging or allocating to the private fund regulatory, examination, or compliance fees or expenses of the adviser, unless such fees and expenses are disclosed to investors;
• reducing the amount of an adviser carried interest clawback by the amount of certain taxes (or assumed taxes), unless the adviser discloses the pre-tax and post-tax amount of the clawback to investors;
• charging or allocating fees or expenses related to a portfolio investment on a non-pro rata basis, unless the allocation approach is fair and equitable and the adviser distributes advance written notice of the non-pro rata allocation (along with an explanation of why such allocation is fair and equitable);
• charging or allocating to the private fund fees or expenses associated with an investigation of the adviser without disclosure and consent from fund investors (the Rules also prohibit charging or allocating such fees or expenses if the investigation results in a sanction for violating the Advisers Act); and
• borrowing money, securities, or other fund assets, or receiving an extension of credit, from a private fund client without disclosure to, and consent from, fund investors.

Finally, the Rules require all SEC-registered investment advisers, including those that do not advise private funds, to document the annual review of their compliance policies and procedures in writing.

Registered Private Fund Advisers

The quarterly statement, private fund audit, and adviser-led secondaries requirements discussed below apply to SEC-registered private fund advisers, but do not apply to exempt reporting advisers. In adopting the Rules, the SEC also noted that the quarterly statement, private fund audit, and adviser-led secondaries requirements are substantive rules under the Advisers Act that do not apply with respect to the non-US private fund clients of an SEC-registered offshore adviser (regardless of whether such vehicles have US investors).

Quarterly Statements

The Rules require a registered private fund adviser to prepare and distribute a quarterly statement that includes specified information regarding fees, expenses, and performance for any private fund it advises, and to distribute the quarterly statement to such fund’s investors within 45 days after the end of each of the first three calendar quarters and within 90 days after the end of each fiscal year.Funds of funds will be required to distributed quarterly statements within 75 days after the end of the first three fiscal quarters of each fiscal year and 120 days after the end of each fiscal year. For a newly formed private fund, the Rules require a quarterly statement to be prepared and distributed beginning after the fund’s second full fiscal quarter of generating operating results.Notably, neither the Rules nor the adopting release define “operating results” though those likely include a fund’s incursion of fees and expenses as well as costs of any investments.

Fees and Expenses. The Rules require such statement to include the following in table format:

• 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, with separate line items for each category of allocation or payment reflecting the total dollar amount and presented both before and after the application of any offsets, rebates, or waivers;
• A detailed accounting of all fees and expenses allocated to or paid by the private fund during the reporting period, including, but not limited to, organizational, accounting, legal, administration, audit, tax, due diligence, and travel expenses, with separate line items for each category of fee or expense reflecting the total dollar amount and presented both before and after the application of any offsets, rebates, or waivers; and
• The amount of any offsets or rebates carried forward during the reporting period to subsequent periods to reduce future management fee payments to the adviser or its related persons.

Portfolio Investment-Level Disclosure. The Rules also require such statement to include the following in table format:

• A detailed accounting of all portfolio investment compensation allocated or paid to the investment adviser, or any of its related persons, by each “covered portfolio investment”The Rules define a “covered portfolio investment” as a portfolio investment that allocated or paid the investment adviser or its related persons portfolio investment compensation during the reporting period. on an investment-by-investment basis during the reporting period (both before and after the application of any offsets, rebates, or waivers), including, but not limited to, origination, management, consulting, monitoring, servicing, transaction, administrative, advisory, closing, disposition, directors, trustees, or similar fees or payments by the covered portfolio investment.

Calculations and Cross References to Organizational and Offering Documents. The Rules require each quarterly statement to include prominent disclosure regarding the manner in which expenses, payments, allocations, rebates, waivers, and offsets are calculated, as well as cross-references to the relevant sections of the private fund’s organizational and offering documents that set forth the applicable calculation methodology.

Performance Disclosure. The Rules require each quarterly statement to provide standardized information regarding the private fund’s performance. As an initial matter, advisers must determine whether a private fund is a liquid fund or an illiquid fund. The Rules define an “illiquid fund” as a private fund that (i) is not required to redeem interests upon an investor’s request (other than for legal, regulatory or policy reasons such as a pension plan required to redeem its interests under state or local law); and (ii) has limited opportunities, if any, for investors to withdraw before termination of the fund. The Rules define a “liquid fund” as any private fund that is not an illiquid fund. The SEC noted that most traditional hedge funds likely fall into the liquid fund bucket. Accordingly, most venture capital, traditional private equity and other similar closed-end funds would generally be classified as illiquid funds so long as opportunities to redeem are limited.

• For liquid funds, the statement must provide (A) annual net total returns for each fiscal year over the past 10 fiscal years or since inception (whichever is shorter), (B) average annual net total returns over one-, five-, and ten-year fiscal periods, and (C) the cumulative net total return for the current fiscal year as of the most recent fiscal quarter covered by the statement. Net returns are required to be presented; however, the Rules permit the inclusion of gross returns as well.
• For illiquid funds, the statement must provide, since inception, the (A) gross and net internal rate of return, (B) gross and net multiple of invested capital, and (C) 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. Notably, the Rules require that advisers calculate performance measures for an illiquid fund with and without the impact of any fund-level subscription facilities. The Rules also require advisers to provide investors with a statement of contributions to, and distributions from, the illiquid fund.

The different categories of required performance information in the quarterly statement must be displayed with equal prominence. The Rules further require that advisers include prominent disclosure of the criteria used and assumptions made in calculating the performance.

Private Fund Audits

The Rules require registered private fund advisers to cause the private funds they advise to undergo audits in accordance with the audit provision under the Custody Rule. As a result, registered private fund advisers that are currently relying on the “surprise examination” option under the Custody Rule will need to be audited annually in accordance with the audit requirements of the Custody Rule.

The Rules provide certain exceptions for private funds that the adviser does not control and is neither controlled by nor under common control with (e.g., a sub-adviser unaffiliated with the fund), in which case an adviser must “take all reasonable steps” to cause its private fund client to undergo an audit and to cause audited financial statements to be delivered in accordance with the Custody Rule requirements. This exception is not available where the adviser is primary adviser to a private fund, even where such adviser does not serve as the general partner and is not affiliated with the general partner.

In contrast to the proposal, the Rules will not require a written agreement between the adviser or the private fund and the auditor pursuant to which an auditor would have been required to notify the SEC upon the occurrence of certain events. Under the Custody Rule, a similar notification obligation exists only where advisers have engaged an auditor for a surprise examination. The SEC noted, however, that similar requirements could be adopted as part of the proposed Safeguarding Rule, which would amend the Custody Rule. Given that the comment period for the Safeguarding Rule was reopened for an additional 60 days the day the Rules were adopted, it is possible (or even likely) that the notification requirement will be imposed under the Safeguarding Rule.

Under the Rules, advisers would also need to maintain copies of audited financials as well as a record of each addressee and date sent.

Adviser-Led Secondary Fairness or Valuation Opinions

The Rules require a registered adviser to private funds to obtain and distribute, prior to the due date of the election form in respect of any adviser-led secondary transaction (i.e., where advisers offer existing fund investors the option to sell or exchange their interests in the fund for interests in another vehicle advised by the adviser), a fairness opinion or valuation opinion from an independent opinion provider concerning the adviser-led secondary transaction. Because these opinions will need to be distributed to investors (as opposed to just obtained by the adviser), advisers will need to ensure that confidentiality provisions with opinion providers have carveouts for sharing such opinions with fund investors as this is typically highly negotiated (including with respect to related non-reliance considerations).

However, the SEC noted that it would generally not view a transaction as an “adviser-led secondary transaction” if the adviser, at the unsolicited request of an investor, assists in the secondary sale of such investor’s fund interest (in other words, a standard passive transfer requested by an investor).The SEC noted that, in a change from the proposal, the adopted Rules modify the definition of an "adviser-led secondary transaction” from the proposal to exclude tender offers. Pursuant to the Rules, an independent opinion providerThe Rules define an “independent opinion provider” as a person that (i) provides fairness opinions or valuation opinions in the ordinary course of its business and (ii) is not a related person of the adviser. must opine on (i) the fairness of the price being offered to the private fund investors, or (ii) the value (as a single amount or range), for any assets being sold as part of the transaction. Moreover, the Rules require an adviser to prepare and distribute to such investors, prior to the due date of the election form in respect of the adviser-led secondary transaction, a summary of any material business relationships the adviser or any of its related persons has, or has had, with the independent opinion provider within the two-year period immediately prior to the issuance of the fairness opinion or valuation opinion.

The Rules require investment advisers to keep copies of any fairness opinions and material business relationship summaries that are distributed pursuant to the Rules, along with a record of each addressee and date sent.

All Private Fund Advisers

The restricted activities and limits on preferential treatment discussed below apply to registered private fund advisers, as well as to exempt reporting advisers, unregistered advisers, and SEC-registered offshore advisers that advise private funds (with certain exceptions). In adopting the Rules, the SEC noted that the conflicts of interest addressed by these provisions of the Rules can result in significant harm to a private fund and its investors and that such potential harms demonstrate the need for broader application of such provisions.

In a departure from the proposal, which would have outright prohibited certain activities, the Rules instead provide a disclosure-based exception or a disclosure- and consent-based exception for each restricted activity, with the exception of fees and expenses of an investigation that results in sanctions for violating the Advisers Act which are strictly prohibited. In another change from the proposal, the SEC did not adopt the prohibition on fees for unperformed services because they believe such activity is already subject to an adviser’s fiduciary duty obligations to its clients. The SEC also did not adopt the indemnification prohibition as originally proposed on the basis that such activity is already subject to the adviser’s fiduciary duty obligations to its clients and the antifraud provisions.

Restricted Activities with Disclosure Based Exceptions

Regulatory, Compliance, and Examination Fees and Expenses

Under the Rules, a private fund adviser is restricted from charging a private fund for (i) regulatory or compliance fees and expenses of the adviser or its related persons and (ii) fees and expenses associated with an examination of the adviser or its related persons by any governmental or regulatory authority, 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 within 45 days after the end of the fiscal quarter in which the charge occurs. While the Rules only cover regulatory or compliance fees and expenses of an adviser, the SEC declined to delineate which fees and expenses relate to a fund and which fees relate to an adviser.

Reducing Adviser Clawbacks for Taxes

Under the Rules, a private fund adviser is restricted from reducing the amount of an adviser carried interest clawback by actual, potential, or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders. However, an adviser may implement such a tax reduction if it sends a written notice to the investors of the private fund that sets forth the aggregate dollar amounts of its clawback before and after any such tax reduction for actual, potential, or hypothetical taxes within 45 days after the end of the fiscal quarter in which the adviser clawback occurs. In providing an example of the type of disclosure that an adviser can make to satisfy the foregoing requirement, the SEC noted that an adviser could at the end of a private fund’s term include disclosure in the fund’s quarterly statement regarding the aggregate dollar amounts of the adviser clawback before and after the application of any tax reduction. To the extent that advisers reduce carried interest clawbacks by actual, as opposed to hypothetical, taxes, the sponsor will be required to obtain the amount of taxes actually paid by the respective carried interest recipients with respect to carried interest and will need to consider those in light of existing general partner agreements and related documentation.

Certain Non-Pro Rata Fee and Expense Allocations

Under the Rules, a private fund adviser may not directly or indirectly 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,The SEC noted that under the Rules, an adviser is not prohibited from paying a fund’s pro rata portion of any fee or expense with its own capital. In addition, to the extent a fund does not have resources to pay for its share, the final rule does not prohibit an adviser from diluting such fund’s interest in the portfolio investment in a manner that is fair and equitable, subject to applicable laws, rules, or regulations and applicable provisions of the fund’s governing documents. 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 investment 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.

The SEC indicated that whether the non-pro rata charge or allocation of fees and expenses is fair and equitable will depend on factors relevant for the specific expense. These factors could include:

• whether the expense relates to a specific type of security that one private fund client holds;
• whether the expense relates to a bespoke structuring arrangement for one private fund client to participate in the portfolio investment (e.g., the use of blocker funds); or
• one private fund client may receive a greater benefit from the expense relative to other private fund clients, such as the potential benefit to certain insurance investors in “rated note” feeders or parallel funds.
  The SEC indicated that an adviser should consider addressing in its notice to investors in a private fund the relevant factors taken into consideration in determining whether a charge or allocation is fair and equitable, which might include the adviser’s allocation approach and the reason(s) why the adviser believes that its non-pro rata allocation approach is fair and equitable under the circumstances.

Importantly, the SEC declined to define “pro rata,” which allows for some subjectivity in approach.

Restricted Activities with Disclosure and Consent Exceptions

Investigation Expenses

Under the Rules, a private fund adviser may not charge private fund clients for fees and expenses associated with an investigation of the adviser or its related persons by any governmental or regulatory authority, even if the conduct would otherwise be indemnifiable under the applicable private fund governing documents. However, an adviser may charge such expenses where an adviser seeks consent from all investors of a private fund, and obtains written consentThe SEC explained that the consent should include detailed description of the fees as separate line items (e.g., rather than being listed broadly) along with an explanation of how the fee relates to the investigation. from at least a majority in interest of the fund’s investors that are not related persons of the adviser.Notably, the SEC indicated that consent from a fund’s limited partner advisory committee may be insufficient in this regard. However, charging private fund clients for fees and expenses related to an investigation that results (or has resulted) in a court or government authority imposing a sanction for a violation of the Advisers Act is outright prohibited. To the extent that an adviser complies with the exception in this provision but is ultimately sanctioned by a regulator for violating the Advisers Act, the adviser must reimburse the fund for the fees and expenses associated with the investigation, such as attorneys’ fees.

Borrowing

Under the Rules, a private fund adviser may not directly or indirectly borrow money, securities, or other fund assets, or receive a loan or an extension of credit, from a private fund client (collectively, a “borrowing”).The SEC noted that it would not interpret ordinary course tax advances and management fee offsets as borrowings for purposes of this restriction. However, a private fund adviser may engage in borrowings from a private fund client where the adviser distributes a written notice and description of the material terms of the borrowing to the investors of the private fund, seeks their consent for the borrowing, and obtains written consent from at least a majority in interest of the fund’s investors that are not related persons of the adviser. As with the investigation expense consent requirement discussed above, the SEC indicated that a borrowing-related consent from a fund’s limited partner advisory committee may be insufficient in this regard. While the SEC did not prescribe specific material terms that should be disclosed in an effort to provide flexibility, the adopting release noted that depending on the facts and circumstances, such terms could include the amount of money to be borrowed, the interest rate, and the repayment schedule.The SEC further noted that a private fund adviser could provide additional information, including, to the extent relevant, updated post-borrowing disclosure to reflect increases, decreases, or other changes in the borrowing, to help investors understand the nature of the conflict of interest and its potential influence on the adviser. The SEC did not address how these provisions of the Rules would affect investments warehoused to be sold to a fund after a fund closes.

Preferential Treatment

Preferential Rights Subject to Prohibitions

Preferential Redemption Rights. An adviser may not grant an investor in a private fund or in a “similar pool of assets”Under the Rules, a “similar pool of assets” means a pooled investment vehicle (other than an investment company registered under the US Investment Company Act of 1940, as amended, a company that elects to be regulated as such, or a securitized asset fund) with substantially similar investment policies, objectives, or strategies to those of a private fund managed by the investment adviser or its related persons. In a departure from the proposal, the SEC changed the defined term from “substantially similar pool of assets” to “similar pool of assets.” In doing so, the SEC noted that depending on the facts and circumstances, the new definition will likely capture vehicles outside of what the private funds industry would typically view as “substantially similar pools of assets.” The SEC noted that this broadened definition is designed to capture most commonly used private fund structures (or similar arrangements) and prevent advisers from structuring around the prohibitions on preferential treatment. As an example, the SEC cited that in a master-feeder structure, some advisers create custom feeder funds for favored investors and that without a broad definition of “similar pool of assets,” the rule would not preclude such advisers from providing preferential treatment to investors in those custom feeder funds to the detriment of investors in standard commingled feeder funds within the master-feeder structure. Consideration will have to be given for regulatory-driven feeders such as insurance rated note feeders where insurance companies are given certain liquidity upon changes in ratings or “events of default” which would otherwise not (and should not) apply to dissimilarly situated investors. (which latter term is designed to prevent advisers from using fund of one or similar structures designed to avoid this Rule) 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 assets, subject to certain exceptions.The foregoing prohibition does not apply where (1) such ability to redeem is required by law or regulation (e.g., in the case of US governmental plans for violations of placement certificates) or (2) the investment 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 and any similar pool of assets. The foregoing prohibition does not apply where (1) such ability to redeem is required by law or regulation (e.g., in the case of US governmental plans for violations of placement certificates) or (2) the investment 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 and any similar pool of assets. As an example of a material, negative effect, the SEC noted in the adopting release that selective disclosure of certain information may entitle the investor privy to such information to avoid a loss (e.g., by submitting a redemption request) at the expense of the non-privy investors.

Preferential Information Rights. An adviser may not provide information regarding the portfolio holdings or exposures of the private fund or a similar pool of assets to any investor 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. As an example of a material, negative effect, the SEC noted that if an adviser provides preferential information about a hedge fund’s holdings to one investor as opposed to another investor, the investor with preferential information may use that information to redeem from the hedge fund during the next redemption cycle, even if both investors have the same redemption rights. In assessing materiality under this provision, the SEC indicated that it is easier to trigger the material, negative effect provision in a scenario in which certain investors receive preferential information and an ability to redeem their interests because those investors can exit the fund sooner than others, potentially harming remaining investors. The SEC further noted that preferential information rights provided to one or more investors in an illiquid private fund generally would not be viewed as having a material, negative effect on other investors.The SEC declined to provide a blanket exemption for all closed-end funds given that they may provide redemption rights under certain extraordinary circumstances. The foregoing prohibition on preferential information rights does not apply where the investment adviser offers such information to all other existing investors in the private fund and any similar pool of assets at the same time or substantially the same time.

Preferential Rights Subject to Disclosure Requirements

For all other preferential rights, the Rules impose a disclosure obligation, with a possible advance delivery obligation that turns on whether any such information relates to “material economic terms”. This approach is a change from the original proposal.

Advance Written Notice. An investment 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. This effectively means that limited side letter compendiums will need to be disclosed prior to each fund’s closing unlike current practice where most funds distribute side letters in connection with “most favored nations” elections post-final closing, although the Rules are not clear about the timing in which side letters entered into at the same time as (as opposed to prior to) the applicable closing need to be disclosed (i.e., at the applicable closing even though actually not yet effective or at subsequent closings after actually being entered into).

Written Notice for Current Investors. An investment adviser must provide disclosure to investors of all preferential treatment the adviser or its related persons has provided to other investors in the same private fund with different protocols depending on whether the funds are classified as “liquid” or “illiquid”.

Liquid Fund. For liquid funds, investment advisers must provide, 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 has provided to other investors in the same private fund.

Illiquid Fund. For illiquid funds, investment advisers must provide, 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 has provided to other investors in the same private fund.

In terms of content, an adviser must specifically describe the preferential treatment provided to investors. The SEC noted that an adviser could comply with this requirement by providing copies of side letters (with the identity of other investors redacted) or providing a summary of the preferential terms provided to other investors in the fund. With respect to the disclosure of preferential fee terms, the SEC indicated that mere disclosure that other investors are paying lower fees is not sufficient for purposes of the Rules. In this regard, the SEC noted that if an adviser provides an investor lower fee terms in exchange for a significantly higher capital contribution than paid by others, an adviser must describe the lower fee terms, including the applicable rate (or range of rates if multiple investors pay such lower fees), in order to provide specific information as required by the Rules.

The SEC declined to adopt a specific timeframe within which such written disclosures must be provided to investors, providing some flexibility based on the complexity of a particular fund. However, the SEC noted that it would be appropriate to distribute these notices within four weeks of the end of the fund’s fundraising period (for illiquid funds) or the investor’s investment in the fund (for liquid funds).

In addition, on at least an annual basis, an investment adviser must provide 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, if any.

Finally, the SEC did not prescribe a particular method of delivery for any of the foregoing disclosures.

All Registered Advisers

Compliance Rule Amendments

The Rules include amendments to Rule 206(4)-7 under the Advisers Act that require all registered advisers, including those that do not advise private funds, to document the annual review of their compliance policies and procedures in writing. Although many advisers already prepare written annual compliance reviews, Rule 206(4)-7 did not previously require that such reviews be memorialized in written form. In the adopting release, the SEC stated that it believes the new requirement will assist the SEC staff in determining whether an adviser has complied with the annual review requirement of the compliance rule. As always, advisers will need to exercise significant care and attention as to the content of these reviews.

Books and Records Rule Amendments

The Rules include amendments to Rule 204-2 under the Advisers Act (i.e., the “books and records rule”) that require SEC-registered advisers to retain records related to the Rules, including, among others, required notices, quarterly statements and records evidencing the calculation method of figures included therein, audited financial statements, and any fairness or valuation opinions. In a change from the proposal, the Rules also require that SEC-registered advisers retain books and records related to the restricted activities provision. As discussed above, the books and records amendments will also require all advisers — including those that do not advise private funds — to maintain written annual reviews of their compliance programs.

Compliance Dates and Legacy Status

Compliance Dates

The dates by which advisers will be required to comply with the Rules vary with respect to the specific provisions of the Rules and by the size of the private fund adviser. Smaller private fund advisers — those with less than $1.5 billion in assets under management attributable to private funds (calculated as of the last day of the adviser’s most recently completed fiscal year) — will have more time to comply with certain of the Rules than larger private fund advisers (i.e., those with $1.5 billion or more in assets under management attributable to private funds).

The amendment to Rule 206(4)-7, requiring a written annual review, has the earliest compliance date, occurring just 60 days after publication in the Federal Register (which is expected within the next 30 days).

The compliance dates for other provisions are as follows:

All dates will be determined based on the date of publication of the Rules in the Federal Register.

Legacy Status

Compliance with various aspect of the restricted activities and preferential treatment provisions of the Rules will be subject to grandfathering or “legacy status” with respect to existing private funds and their governing agreements. Specifically, the prohibitions on (a) preferential redemption rights, and (b) preferential information rights, as well as the restrictions on (x) borrowing from a private fund without investor consent, and (y) charging a private fund for fees and expense related to certain investigations without investor consent will have legacy status.Note, that legacy status does not permit advisers to charge for 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. The SEC clarified, however, that such legacy status will only apply to agreements with respect to private funds that commence operations before the relevant compliance dates specified above.

Commencement of operations of a private fund includes “any bona fide activity directed towards operating a private fund.” The SEC cited examples of activity that could indicate that a private fund has commenced operations which include: issuing capital calls, setting up a subscription facility for a fund, holding an initial fund closing (which arguably could just be on the sponsor commitment), conducting due diligence on potential fund investments, and making an investment on behalf of a fund.

The SEC chose to grant legacy status only to the restricted activities provisions that involve investor consent and the preferential treatment provisions that involve a prohibition. The SEC did not grant legacy status to provisions that involved disclosure-oriented solutions or exceptions. The SEC noted that it does not consider disclosure of information to be as burdensome or disruptive as other aspects of the Rules and that disclosure based obligations therefore do not warrant legacy treatment.

Conclusion

The Rules substantially increase the compliance burden of private fund advisers and impose significant restrictions on historic practices of registered and unregistered advisers. As a result, advisers should take steps to develop a plan to come into compliance with the Rules well in advance of the applicable compliance dates, which vary based on the particular Rule, each adviser’s registration status, and, in some cases, the amount of private fund assets under management attributable to the adviser.

Endnotes

¹References to a “registered” private fund adviser herein also refers to private fund advisers required to be registered with the SEC.

²“Private funds” are privately offered investment vehicles that pool capital from one or more investors and invest in securities and other instruments or investments. Section 202(a)(29) of the Advisers Act defines the term “private fund” as an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, as amended, but for section 3(c)(1) or 3(c)(7) of that Act. Securitized asset funds, as defined below, are generally excluded from the term “private funds.”

³Adviser-led secondary transaction means any transaction initiated by the investment adviser or any of its related persons that offers private fund investors the choice between: (1) Selling all or a portion of their interests in the private fund; and (2) 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.

⁴Funds of funds will be required to distributed quarterly statements within 75 days after the end of the first three fiscal quarters of each fiscal year and 120 days after the end of each fiscal year.

⁵Notably, neither the Rules nor the adopting release define “operating results” though those likely include a fund’s incursion of fees and expenses as well as costs of any investments.

⁶The Rules define a “covered portfolio investment” as a portfolio investment that allocated or paid the investment adviser or its related persons portfolio investment compensation during the reporting period.

⁷The SEC noted that, in a change from the proposal, the adopted Rules modify the definition of an "adviser-led secondary transaction” from the proposal to exclude tender offers.

⁸The Rules define an “independent opinion provider” as a person that (i) provides fairness opinions or valuation opinions in the ordinary course of its business and (ii) is not a related person of the adviser.

⁹The SEC noted that under the Rules, an adviser is not prohibited from paying a fund’s pro rata portion of any fee or expense with its own capital. In addition, to the extent a fund does not have resources to pay for its share, the final rule does not prohibit an adviser from diluting such fund’s interest in the portfolio investment in a manner that is fair and equitable, subject to applicable laws, rules, or regulations and applicable provisions of the fund’s governing documents.

¹⁰The SEC explained that the consent should include detailed description of the fees as separate line items (e.g., rather than being listed broadly) along with an explanation of how the fee relates to the investigation.

¹¹Notably, the SEC indicated that consent from a fund’s limited partner advisory committee may be insufficient in this regard.

¹²The SEC noted that it would not interpret ordinary course tax advances and management fee offsets as borrowings for purposes of this restriction.

¹³The SEC further noted that a private fund adviser could provide additional information, including, to the extent relevant, updated post-borrowing disclosure to reflect increases, decreases, or other changes in the borrowing, to help investors understand the nature of the conflict of interest and its potential influence on the adviser.

¹⁴Under the Rules, a “similar pool of assets” means a pooled investment vehicle (other than an investment company registered under the US Investment Company Act of 1940, as amended, a company that elects to be regulated as such, or a securitized asset fund) with substantially similar investment policies, objectives, or strategies to those of a private fund managed by the investment adviser or its related persons. In a departure from the proposal, the SEC changed the defined term from “substantially similar pool of assets” to “similar pool of assets.” In doing so, the SEC noted that depending on the facts and circumstances, the new definition will likely capture vehicles outside of what the private funds industry would typically view as “substantially similar pools of assets.” The SEC noted that this broadened definition is designed to capture most commonly used private fund structures (or similar arrangements) and prevent advisers from structuring around the prohibitions on preferential treatment. As an example, the SEC cited that in a master-feeder structure, some advisers create custom feeder funds for favored investors and that without a broad definition of “similar pool of assets,” the rule would not preclude such advisers from providing preferential treatment to investors in those custom feeder funds to the detriment of investors in standard commingled feeder funds within the master-feeder structure. Consideration will have to be given for regulatory-driven feeders such as insurance rated note feeders where insurance companies are given certain liquidity upon changes in ratings or “events of default” which would otherwise not (and should not) apply to dissimilarly situated investors.

¹⁵The foregoing prohibition does not apply where (1) such ability to redeem is required by law or regulation (e.g., in the case of US governmental plans for violations of placement certificates) or (2) the investment 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 and any similar pool of assets.

¹⁶The SEC declined to provide a blanket exemption for all closed-end funds given that they may provide redemption rights under certain extraordinary circumstances.

¹⁷Note, that legacy status does not permit advisers to charge for 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.