In August 2023, the Securities and Exchange Committee (SEC) adopted new and amended rules governing private fund advisers. Under the Investment Advisers Act of 1940 (the Advisers Act), private fund advisers are either (i) subject to full registration as registered investment advisers (RIAs) under the Advisers Act (generally, advisers to non-venture capital funds with over $150 million in assets under management) or (ii) exempt reporting advisers (ERAs) (generally, advisers to venture capital funds or advisers solely to private equity, hedge, or other investment funds under $150 million in assets under management). Widely anticipated by market participants since they were proposed in February 2022, the rules will have far-reaching impacts on private fund advisers’ reporting obligations, internal governance, and compliance practices.

The new and amended rules include:

For all Private Fund Advisers:

• Restrictions on certain activities that indicate conflicts of interests or lack of transparency, unless disclosed or, in some cases, investor consent is obtained.
• Prohibitions on many forms of preferential treatment.

For Registered Investment Advisers to Private Funds:

• Quarterly reporting of fees, expenses, and fund performance.
• Annual audits of each fund.
• Independent fairness or valuation opinions in connection with adviser-led secondary transactions.

Requirements Applicable to All Private Fund Advisers: All private fund advisers, whether registered with the SEC or not, will be required to comply with the following new or amended rules.

Restricted Activities. Rather than strictly prohibit certain activities, which was contemplated by the proposed rules, the final rules designate certain activities as restricted. These restricted activities are permitted only if disclosure to investors is made and, in some cases, the consent of investors is obtained. The policy rationale for these reforms is to inform and seek certain approvals from investors in connection with conflicts of interest.

• Charging or allocating to the private fund the fees or expenses incurred in connection with an investigation into the adviser or its related persons by any governmental or regulatory authority, unless disclosure is made to, or consent is obtained from investors; however, regardless of any disclosure or consent, an adviser may not charge or allocate fees and/or expenses involving sanctions for violation of the Advisers Act or the rules promulgated thereunder;
• Charging or allocating to the private fund any regulatory or compliance fees or expenses of the advisers or its related persons to the fund, unless the fees or expenses are disclosed to investors;
• Reducing the amount of an adviser clawback by actual, potential, or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders, unless the pre- and post-tax amounts of the adviser clawback are disclosed to investors;
• Charging or allocating fees and/or expenses related to a portfolio investment on a non-pro rata basis when multiple private funds and other clients advised by such adviser or its related persons have invested (or propose to invest) in the same portfolio investment unless such non-pro rata allocation is fair and equitable and advance notice is provided to investors in writing; and
• Borrowing money, securities, or other private fund assets, or receiving a loan or an extension of credit from a private fund client, unless the arrangements are disclosed to, and consent to the same is obtained from, investors.

Preferential Treatment. Private fund advisers will be prohibited from granting preferential terms to investors with respect to redemption rights or information rights if the adviser reasonably expects those rights to have a material, negative effect on other investors. More generally, private fund advisers will be prohibited from providing preferential treatment to investors unless certain disclosures are made prior to investment and the terms are disclosed in full after investment.

Exemptions for Legacy Private Fund Agreements. With respect to governing agreements of private fund agreements that were or are entered into prior to the compliance date described below, the SEC is providing legacy status for the portions of the restricted activities rule that require investor consent and the portions of the preferential treatment rule that prohibit preferential redemption rights and information rights. As a result, private funds will not be required to amend governing agreements that predate the compliance date to comply with these portions of the rules.

Requirements Applicable Only to Registered Private Fund Advisers: Registered private fund advisers are subject to additional obligations under the recently adopted rules.

Quarterly Statements. Registered private fund advisers will be required to distribute quarterly statements to investors. The statements must provide fund-level performance information (i.e., information that is not aggregated for multiple funds). In addition, the statements must report the cost to invest in each private fund, fees and expenses that have been paid by the private fund, and compensation paid to the registered private fund adviser.

Annual Private Fund Audits. Each registered private fund adviser must cause each private fund that it advises to undergo an annual financial statement audit.

Adviser-Led Secondary Transactions. The rules require registered private fund advisers to obtain a fairness opinion or valuation opinion in connection with an adviser-led secondary transaction (i.e., an offer to current investors of the option between (i) selling their interests in a private fund or (ii) converting or exchanging those interests for interests in another vehicle advised by the same adviser or any of its related persons).

Books and Records Rule Amendments. The final rules amend pre-existing recordkeeping rules to require registered private fund advisers to retain books and records related to the quarterly statement, the annual audit, adviser-led secondary transaction, and preferential treatment rules.

Private Fund Compliance Programs. Registered private fund advisers must conduct a review, at least annually, of their compliance policies and document the review in writing.

Compliance Dates: The compliance date for the preferential treatment, restricted activities, and adviser-led secondary transaction rules is (i) 12 months after the publication in the Federal Register for those private fund advisers with $1.5 billion or more in private fund assets and (ii) 18 months after the publication in the Federal Register for those private fund advisers with less than $1.5 billion in private fund assets. The compliance date for the quarterly statement and private fund audit rules will be 18 months after publication in the Federal Register. The compliance date for registered private fund advisers to meet the compliance program requirements is only 60 days after publication in the Federal Register. Though private fund advisers will have a year or more before having to observe the new and amended rules, they should begin considering the impacts on their operations, governing fund documents, and compliance plans now.

The adopting release for the new and amended private fund rules is available on the SEC’s website here.