New Era of Private Fund Adviser Reforms (Update)

By Bryan Jacobsen

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‍Private Fund Rule Repeal

On June 5, 2024 the New Orleans-based 5th Circuit Court of Appeals, in a 3-0 decision, found that the SEC exceeded its authority by adopting the Private Fund Rule in August of 2023.  As of June 6, 2024,  An SEC spokeswoman said the regulator is reviewing the decision and will determine its next steps.

See below for the an overview of the rule.

Private Fund Rule Overview

Private funds and their advisers have become increasingly significant in our financial markets. As a result, the Securities and Exchange Commission (SEC) adopted new rules and amendments in August, 2023, under the Investment Advisers Act of 1940, to enhance the regulation of private fund advisers. The reforms aimed to protect investors and increase transparency in the private fund industry.

Why Do Private Fund Adviser Reforms Matter?

Private funds indirectly impact individuals through their participation in public and private pension plans, endowments, foundations, and certain retirement plans. As private funds continue to grow, regulators seek to ensure that private fund investors are protected and have access to relevant information about their investments.

The SEC’s reforms were designed to address practices that may pose significant risks and harm to investors and private funds. By increasing visibility, establishing requirements to address potential investor harm, and prohibiting or restricting certain activities, these reforms aimed to safeguard the interests of those who invest directly or indirectly in private funds.

Reform Requirements

The SEC’s reforms introduced several requirements for registered private fund advisers to enhance transparency and accountability. These requirements included:

Quarterly Statement (Rule 211(h)(1)-2). Registered private fund advisers must provide quarterly financial statements to private fund investors. These statements should include information on fund performance, fees, expenses, compensation, and other amounts paid to the adviser. This provision ensures that investors have a clear understanding of the costs associated with their investments and the performance of the private fund.

Private Fund Audits (Rule 206(4)-10). Registered private fund advisers are required to arrange financial statement audits for the private funds they advise. These audits should adhere to the requirements outlined in the Custody Rule (Rule 206(4)-10). By conducting these audits, private fund advisers can ensure accurate valuation of fund assets and protect investors against potential misappropriation of assets.

Adviser-Led Secondaries (Rule 211(h)(2)-2). Under the reforms, registered private fund advisers must obtain a fairness opinion or a valuation opinion when offering existing fund investors the option to sell their interests in a private fund or convert/exchange their interests for interests in another vehicle advised by the same adviser. This rule aims to mitigate conflicts of interest and provide transparency regarding the adviser’s relationships and potential biases in structuring such transactions.

Books and Records Rule Amendments. To facilitate the SEC’s assessment of adviser compliance with the rules, the reforms include amendments to the Books and Records Rule, Investment Advisers Act of 1940 Rule 204-2(a)(21)(i). These amendments require registered private fund advisers to maintain comprehensive documentation of their compliance policies and procedures. This documentation enables the SEC to evaluate advisers’ compliance and identify potential weaknesses in their compliance programs.

Restricted Activities (Rule 211(h)(2)-1). The reforms introduce a new rule that restricts private fund advisers from engaging in activities that are contrary to the public interest and investor protection. These activities include charging or allocating fees or expenses associated with investigations without investor disclosure and consent, charging regulatory or compliance fees without disclosure, reducing clawbacks by certain taxes without disclosure, and more.

Preferential Treatment (Rule 211(h)(2)-3). To prevent preferential treatment that negatively affects other investors, the reforms prohibit private fund advisers from providing preferential terms regarding certain redemptions from the fund and preferential information about portfolio holdings or exposures. The rule requires full disclosure of terms and equal treatment of all investors to ensure fairness and transparency.

The reforms also introduced requirements applicable to all private fund advisers, regardless of registration status. These requirements included amendments to the compliance rule under the Advisers Act (Section 204A), mandating all registered investment advisers to document their annual review of compliance policies and procedures. This written documentation was intended to help the SEC evaluate advisers’ compliance with the rules and identify potential weaknesses in their compliance programs.

It is important to note that the Quarterly Statement Rule, Private Fund Audit Rule, Adviser-Led Secondaries Rule, Restricted Activities Rule, and Preferential Treatment Rule did not apply to investment advisers with respect to securitized asset funds they advise.

What’s Next?

Compliance dates for the various rules depend on the private fund assets under management:

  • For the Private Fund Audit Rule and the Quarterly Statement Rule, the compliance date will be 18 months after publication in the Federal Register.
  • For the Adviser-Led Secondaries Rule, Preferential Treatment Rule, and Restricted Activities Rule, advisers with $1.5 billion or more in private fund assets under management must comply within 12 months after publication, while advisers with less than $1.5 billion have 18 months to comply.
  • Compliance with the amended Advisers Act compliance rule will be required 60 days after publication in the Federal Register.

By requiring quarterly statements, audits, fairness opinions, and documentation of compliance policies, these reforms provided investors with the information needed to make informed decisions. The restrictions on certain activities and preferential treatment were designed to further ensure fairness and protect the interests of all investors.

Partnering for Compliance Success

Our experts understand how to design practical and reasonable regulatory compliance programs. Oyster Consulting will work with you and your team to ensure that your policies are updated to reflect new regulatory requirements.

Keep your compliance program on track and minimize risk with Oyster Solutions compliance management software. Workflows specific to your firm’s policies ensure that your policies are followed and enforced. From attestations and marketing approvals to testing and surveillance, you’ll have the information and tools you need at your fingertips to keep your firm compliant. When you use Oyster Solutions compliance software, your firm has a central repository for documentation and the appropriate operational controls, supervision and compliance oversight you need.

About The Author
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Bryan Jacobsen

Bryan’s role as a CCO for dual registered broker-dealer / RIAs, clearing firms and crypto-based entities enables him to apply his FinTech, financial, crypto, blockchain, and regulatory knowledge when providing practical compliance solutions.