Private Fund managers are a growing part of the securities marketplace. In the SEC’s 2022 EXAM priorities, they note that 35% of all Registered Investment Advisors (RIAs) manage $18 trillion in private fund assets – a 70% increase in the last five years. At the same time, the Accredited Investor status necessary to invest in 3(c)(1) funds is a much smaller hurdle than when Reg D was adopted in 1982, and with the most recent changes in 2020 that expanded the definition. It’s no surprise that a growing market for sophisticated investors would draw scrutiny when the hurdle for sophistication has effectively dropped over time while an expanding segment of the marketplace has become increasingly opaque.
Private Fund managers are not a new focus for the Exam Priorities release. In fact, the SEC has had their eye on certain aspects of Private Fund management for a while. The SEC released a Risk Alert last June, which was updated again in January, before releasing proposed private fund reforms in a February fact sheet. Some of the common themes have been showing up in enforcement actions for several years, often in high-profile cases.
The new Private Fund rules are still in the comment period, but with a 3-1 Commission since Elad Roisman’s resignation in January we are not likely to see substantial changes. In the new rules, the SEC will focus on the following:
Quarterly Statements which detail performance, fees, and expenses will be mandatory.
Annual Audits of private funds will become mandatory, with required reporting of certain events to be included in the audit agreement.
Advisor-led secondary transactions, which often mean swapping the tail end of an older, run-off fund for a shiny new one, will now require a fairness opinion.
Prohibited Activities receive their own sub-heading and will include:
- closer examinations of fees and expenses, especially their calculation and the fairness of how expenses are allocated
- limitations on the ability to limit liability or seek indemnification in the context of the advisor’s services to the funds
- borrowing from a Private Fund by a manager
- Reducing certain advisor tax claw-backs
Preferential Treatment of certain investors or classes of investors will be prohibited as well, especially as it relates to redemptions, portfolio holdings, or other material matters.
Note that many of these will only apply to Investment Advisors who are registered with the SEC. This means that many offshore advisors who only market 3(c)(7) funds (whose Qualified Purchasers are considered more able to conduct the necessary due diligence on their own) will not be subject to these requirements. This is consistent with the new marketing rules, where some provisions specifically apply to private funds managed by registered advisors.
Oyster works with advisors to Private Funds to ensure that they are managing regulatory risks and are prepared for new requirements as the regulatory landscape continues to evolve. Our experts have a deep understanding of the requirements of the Investment Advisors Act and how the Act applies to Private Funds.