A foundation of hedge fund compliance knowledge and processes is critical to meeting regulatory standards, but it’s also just the beginning – it’s equally important to stay aware of compliance updates, be that SEC Risk Alerts, amendments or other proposed changes.
Related: Beyond the Checklist: The Strategic Value of Compliance Program Management for Hedge Funds
And with significant rule changes adopted by the SEC in 2023, hedge fund managers would be wise to review their current processes in light of new regulations.
With that in mind, here are five important hedge fund regulation updates to review before diving into 2024, including disclosures, account statements, annual audits and more.
Five Compliance Hedge Fund Updates to Know Going into 2024
1. General Disclosures
In August of 2023, the SEC officially adopted new disclosure requirements for hedge funds. Several of these new disclosure rules apply to all hedge fund firms, including those that meet exemption status.
These include the following:
- Advisors may not charge or allocate any fees associated with regulatory, compliance or examination fees of the adviser (or related persons) without proper disclosure. The disclosure must include the amount and details of the expense, and be provided to investors within 45 days of the end of each quarter.
- Advisers must disclose any fees charged to the hedge fund relating to costs of an investigation. Any expenses related to the investigation of the adviser (or related persons) must have the amount disclosed and a description of its relevance, and gain informed consent from investors. Additionally, if the investigation results in a sanction or violation, the amounts must be refunded – regardless of the disclosure.
- Any post-tax clawbacks must be disclosed. This includes the total amount of the clawback both before and after any reductions.
- Advisers must disclose and gain investor consent to borrow money from the hedge fund.
- Advisers must provide advance written notice to investors of any fee and expense allocation that is done on a non-pro rata basis. These disclosures will need to include a description of how the allocation approach is fair and equitable.
Note that the above list isn’t exhaustive of all required disclosures, and some of the disclosures may be required in advance and/or need informed consent in addition to the disclosures. We recommend a comprehensive review of the updated disclosure rules via the SEC’s Final Ruling document.
2. Quarterly Account Statements
Moving forward, all registered hedge fund managers will also be required to provide quarterly account statements to investors. Per the SEC’s final ruling:
“The quarterly statement rule is designed to facilitate the provision of simple and clear disclosures to investors regarding some of the most important and fundamental terms of their relationships with 60 investment advisers to private funds in which those investors invest—namely what fees and expenses those investors will pay and what performance they receive on their private fund investments.”
The statements should include:
- Details of the fund’s fees
- Any expenses to the account
- A performance report
Statements should be distributed within 45 days of the end of each fiscal quarter and 90 days from the end of the fiscal year. Advisers are required to use clear language and a consistent format across statements.
3. Preferential Treatment Disclosures
Next up on our list of hedge fund compliance updates: preferential treatment of clients.
The updated rules specifically address equal treatment of clients, prohibiting:
1. “granting an investor in a private fund or in a substantially similar pool of assets the ability to redeem its interest on terms that the advisor reasonably expects to have a material, negative effect on other investors in that private fund or in a substantially similar pool of assets, and
2. providing information regarding portfolio holdings or exposures of a private fund or of a substantially 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 substantially similar pool of assets.”
If any other preferential treatment exists, advisers will need to disclose that information to current investors at least annually and to prospective investors prior to their involvement.
4. Annual audits
Hedge fund managers will need to conduct an annual audit in 2024 and subsequent years, to be conducted by an independent public accountant that is registered with, and subject to regular inspection by, the PCAOB. There will need to be a separate audit for each individual fund.
Advisers will need to distribute these audit reports to investors within 120 days of the fiscal year end.
While some advisers are concerned with the increased costs and time necessary to meet these requirements, an Investment Executive article reports that “new annual audit requirements could be satisfied by complying with current custody rules, rather than through a new set of requirements.”
5. Form PF Amendments
In May of 2023, the SEC adopted amendments to the Form PF, which is the confidential reporting form for certain advisers, including some hedge fund managers. In particular, these new rules apply to hedge fund managers with at least $1.5 billion in hedge fund AUM.
Related: When Does an RIA Firm Managing a Private Fund Need to File a Form PF?
The amendment includes new guidelines that require hedge fund advisers to update their Form PF in situations that “may indicate significant stress at a fund that could harm investors or signal risk in the broader financial system.” Some examples of such events include extraordinary investment losses or significant margin and default events.
If a qualifying event occurs, large hedge fund advisers ($1.5 billion or more in AUM) will have 72 hours to report it via an update to their Form PF. All other private fund advisers will have 60 days from the end of the fiscal quarter to file an incident report.
Additionally, the new Form PF rule expands annual reports to include:
- “Strategies employed by firms,
- Use of leverage, and
- Clawbacks of a general partner’s performance compensation or a limited partner’s distributions”
As the year draws to a close, it’s imperative that all hedge fund advisers revisit their Form PF and ensure they are prepared to meet updated requirements.
Looking Ahead: Hedge Fund Compliance in 2024 and Beyond
The above updates have put pressure on many hedge fund managers to increase spending on compliance processes, with a report from the Financial Times stating that several are considering hiring extra staff to meet the demands. The SEC estimates annual audits and quarterly reports to cost nearly $1 billion alone.
That same report notes that “the whole compliance process will be complicated by another SEC pending proposal that would tighten requirements for outsourcing functions from custody to tech.”
And a recent survey from Hedgeweek echoes that concern, with 50% of respondents in North America citing Private Fund adviser rule proposals as a top three concern for 2024.
Hedge fund advisers who wish to stay ahead of the curve for compliance in the new year would do well to stay updated on both recent regulatory changes as well as proposed amendments. With this list of five recent hedge fund compliance updates in mind, such advisers can begin reviewing their processes and preparing for the future.
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