On August 23, 2023, the Securities and Exchange Commission (SEC) voted to adopt new rules and amendments under the Investment Advisers Act of 1940 (Advisers Act) to the regulation of private fund advisers (Final Rule). The SEC adopted the Final Rule to provide additional protections to investors in private funds, increase transparency into certain adviser practices, and address adviser practices that could potentially harm investors.

The Final Rule is intended to achieve various objectives for protecting investors in private funds. Objectives include:

• Providing better transparency and reporting to private fund investors by providing quarterly statements to investors detailing fund performance, fees, expenses and adviser compensation.
• Restricting certain practices without disclosure or investor consent, such as charging or allocating to the private fund fees or expenses associated with an investigation of the adviser without disclosure and consent from fund investors.
• Requiring audits to be distributed annually to private fund investors.
• Avoiding preferential treatment towards certain investors by prohibiting preferential treatment to particular investors that would have a material, negative effect on other investors, and restricting other practices that confer preferential treatment.
• Avoiding conflicts of interest in adviser-led secondary transactions by requiring a fairness opinion or valuation opinion issued by an independent opinion provider, to be obtained in connection with secondary transactions that are led by a private fund adviser to a transacting private fund distributed to investors in this fund.

For Registered Private Fund Advisers
For private fund advisers that are SEC-registered investment advisers (not including exempt reporting advisers):

Quarterly Statement Rule
The Final Rule now requires registered private fund advisers to provide private fund investors with a quarterly statement that discloses information related to fees and expenses paid by the private fund, including certain compensations and other amounts paid to the adviser(s), performance, and the cost of investing in the private fund. These quarterly statements must be delivered by fund adviser(s) to all investors in their 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. Private fund 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. Also, these quarterly statements must comply with specific formatting and reporting requirements.

Private Fund Audit Rule
The Final Rule also requires registered private fund advisers to conduct a financial statement audit for each private fund they manage. These audits must meet the same audit criteria as outlined under Rule 206(4)-2 of the Advisers Act, otherwise known as the “Custody Rule.”

Adviser-Led Secondary Transactions Rule
In connection with adviser-led secondary transactions, the Final Rule now requires a registered private fund adviser to obtain either a fairness opinion or a valuation opinion from an independent provider with respect to such transactions. In addition to the fairness or valuation opinion, the Final Rule also requires that registered private fund advisers prepare and distribute to the private fund’s investors a summary of any material business relationships the adviser has, or has had within the prior two years, with the independent opinion provider. The Final Rule states that the fairness or valuation opinion, as well as the written summary of material business relationships, must be furnished to investors prior to the due date of the election form for the transaction.

Books and Records Rule Amendments
To facilitate the SEC’s ability to review an adviser’s compliance with the rules, the Final Rule requires registered advisers to keep records in writing of the annual review of their compliance policies and procedures and the effectiveness of such policies and procedures.

For All Private Fund Advisers
The SEC further adopted additional rules applicable to all investment advisers to private funds, whether or not they are registered investment advisers with the SEC, including exempt reporting advisers, but excluding investment advisers with respect to advised securitized asset funds and certain other funds that do not meet the “private fund” definition. The Final Rule enacted both a Restricted Activities Rule and a Preferential Treatment Rule.

Restricted Activities Rule
Meant to address certain conflicts of interest that may lead to investor harm, the Final Rule implements reforms that prohibit all private fund advisers from engaging in the following activities:

• Charging or allocating its private fund for fees or expenses associated with an investigation of the adviser without disclosure and consent from fund investors. Regardless of whether a private fund adviser obtains consent, it is still prohibited from charging its private fund 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.
• Charging or allocating its private fund for 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 clawback by the amount of certain 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 (1) the allocation approach is fair and equitable and (2) the adviser distributes advance written notice of the non-pro rata charge and a description of how the allocation approach is fair and equitable under the circumstances.
• Borrowing or receiving an extension of credit from a private fund client without disclosure to, and consent from, fund investors.

Preferential Treatment Rule
Meant to restrict specific types of preferential treatment to certain investors, the Preferential Treatment Rule prohibits all private fund advisers from providing preferential terms to investors related to: (i) certain redemptions from the fund, unless the ability to redeem is required by applicable law or the adviser offers the preferential redemption rights to all other investors without qualification; and (ii) certain preferential information about portfolio holdings or exposures, unless such preferential information is offered to all investors.

Additionally, the Preferential Treatment Rule prohibits all private fund advisers from providing preferential treatment to investors, unless certain terms are disclosed in advance of an investor’s investment in the private fund and all terms are disclosed after the investor’s investment.

Legacy Status
The Final Rule only provides legacy status for the information and redemption aspects of the Preferential Treatment Rule and certain aspects of the Restricted Activities Rule that require investor consent. Notably, the legacy status provisions apply to governing agreements that were entered into prior to the compliance date if the applicable rule would require the parties to amend the agreements.

For All Registered Advisers
Compliance Rule Amendments. The Final Rule amends the compliance rule under the Advisers Act requiring all registered advisers, including those that do not advise private funds, to document in writing the required annual review of their compliance policies and procedures and all registered advisers must comply within sixty days after publication in the Federal Register.

Conclusion
With this overhaul to disclosure and regulatory practices of the private funds industry, private fund advisers should familiarize themselves with the new reporting information, disclosure, and consent requirements with regard to certain matters.

The Final Rule has the following compliance dates: (i) the compliance date for the private fund audit rule and the quarterly statement rule is 18 months after publication in the Federal Register; (ii) the compliance date for the Adviser-Led Secondary Rule, the Preferential Treatment Rule, and the Restricted Activities Rule is 12 months after publication in the Federal Register for advisers with at least $1.5 billion private fund assets under management and 18 months after publication in the Federal Register for advisers under the $1.5 billion threshold; and (iii) The Final Rule will become effective 60 days after publication in the Federal Register.