On February 9, 2022, the U.S. Securities and Exchange Commission (“SEC”) formally proposed new rules and amendments. The proposed reforms are intended to protect private fund investors; increasing their visibility into certain practices, establishing requirements to address practices that have the potential to lead to investor harm, and prohibiting adviser activity that is contrary to the public interest and the protection of investors.
These reforms are aimed to enhance the regulation of private fund advisers. The SEC published a Fact Sheet overviewing the reforms, highlighting these five aspects;
- Require private fund advisers registered with the SEC to provide investors with quarterly statements detailing information about private fund performance, fees, and expenses;
- Require registered private fund advisers to obtain an annual audit for each private fund and cause the private fund’s auditor to notify the SEC upon certain events;
- Require registered private fund advisers, in connection with an adviser-led secondary transaction, to
distribute to investors a fairness opinion and a written summary of certain material business relationships between the adviser and the opinion provider; - Prohibit all private fund advisers, including those that are not registered, from engaging in certain activities
and practices that are contrary to the public interest and the protection of investors; and - Prohibit all private fund advisers from providing certain types of preferential treatment that have a material negative effect on other investors, while also prohibiting all other types of preferential treatment unless disclosed to current and prospective investors.
The SEC is also proposing to require all registered investment advisers, including those that do not advise private funds, to document the annual review of their compliance policies and procedures in writing. The Fact Sheet overviews the following proposed rules and amendments:
Quarterly Statement Rule
The proposal would require registered private fund advisors to distribute to private fund investors a quarterly statement containing a detailed accounting of all fees and expenses paid by the private fund during the reporting period, including disclosing information regarding compensation. The proposal will also require advisors to provide information on the performance of the private fund for liquid and illiquid funds.
Private Fund Audit Rule
The proposal would require registered private fund advisers to cause the private funds they advise to undergo a financial statement audit at least annually and also upon liquidation. The audited financial statements would then be distributed to investors promptly after the completion of the audit. These audits would provide an important check on the adviser’s valuation of private fund assets, which often serve as the basis for the calculation of the adviser’s fees, and protect private fund investors against misappropriation of fund assets.
Adviser-Led Secondaries Rule
The proposal would require a registered private fund adviser to obtain a fairness opinion in connection with an adviser-led secondary transaction. In these transactions, advisers often offer existing fund investors the option to sell or exchange their interests in the private fund for interests in another vehicle advised by the adviser. The proposal also would require the adviser to prepare and distribute to the private fund investors a summary of any material business relationships. This requirement would provide a check against an adviser’s conflicts of interest in structuring and leading a transaction from which it may stand to profit at the expense of private fund investors.
Prohibited Activities Rule
The proposal would prohibit all private fund advisers from engaging in certain activities and practices outlined in the proposed rule that are contrary to the public interest and the protection of investors.
Preferential Treatment Rule
The proposal would prohibit all private fund advisers from providing preferential terms to certain investors regarding redemptions from the fund or information about portfolio holdings or exposures. It also would prohibit all private fund advisers from providing other preferential treatment unless disclosed to current and prospective investors. This proposal is designed to protect investors by prohibiting specific types of preferential treatment that have a material, negative effect on other investors
Books and Records Rule Amendments
The proposal includes amendments to the books and records rule under the Advisers Act that require advisers to retain records related to the proposed rules. The amendments would facilitate the SEC’s ability to assess an adviser’s compliance with the proposed rules.
Compliance Rule Amendments
The proposal includes amendments to the compliance rule under the Advisers Act that require all registered advisers, including those that do not advise private funds, to document their annual review in writing.