Today, the Securities and Exchange Commission (SEC) voted 3-2 to approve a set of rules for registered and unregistered investment advisers to private funds with a goal of increasing transparency and investor protections in the fast-growing private fund market, which now includes 5,473 advisers to more than 55,446 funds with an aggregate value of more than $21.1 trillion.
According to the SEC staff and a majority of the Commissioners, these rules are necessary to protect private fund investors from “fraud, deception or manipulation by the investment advisers to those funds,” even though direct investors in private funds are generally considered to have a level of sophistication and acumen necessary to perform appropriate due diligence before investing in a private fund.
Due to the numerous comments submitted by interested parties (including COMPLY) and the thoughtful consideration by the SEC, the final rules were softened, somewhat, from those initially proposed. However, private fund managers will still face potentially significant changes to their business practices and regulatory obligations.
Key Takeaways from the New SEC Rules Regarding Private Fund Advisers and Documentation of Registered Investment Adviser Compliance
The rules require SEC-registered private fund advisers to:
- Provide investors with quarterly statements detailing fund-level or portfolio-level (as applicable) performance for specified time periods, fees and expenses and compensation to the adviser and related parties within 45 days after the end of each of the first three fiscal quarters of each fiscal year and 90 days after the end of each fiscal year.
- Obtain a financial statement audit annually by an independent public accountant that is registered with, and subject to regular inspection by, the PCAOB for each private fund they advise. Such audited financial statements must be distributed to investors within 120 days of the private fund’s fiscal year-end and promptly upon liquidation.
- Obtain either a fairness opinion or a valuation opinion in connection with any adviser-led secondary transaction and prepare and distribute a written summary of any material business relationships between the adviser or its related persons and the independent opinion provider.
The rules require all private fund advisers, whether registered or not, to:
- Disclose to all investors, and obtain consent from the majority of investors, to charge or allocate to the private fund any fees or expenses associated with an investigation of the adviser. However, this practice is entirely prohibited if the investigation results in a sanction for a violation of the Investment Advisers Act of 1940 or rules promulgated thereunder.
- Disclose to, but not gain consent from, investors regarding the charging or allocation of regulatory, examination or compliance fees incurred by the adviser or its related persons to the private fund on a quarterly basis.
- Disclose to investors the pre-tax and post-tax amount of a clawback of certain taxes from the private fund.
- Provide advance written notice to investors of any fee and expense allocation to portfolio investments that is done on a non-pro rata basis, and a description of how the allocation approach is fair and equitable.
- Disclose to and gain consent from investors to borrow or receive an extension of credit from a private fund.
- Not offer preferential redemption or information rights to certain investors unless the adviser has offered the same redemption ability, or access to information, to all existing investors and will continue to offer the same redemption ability or access to information to all future investors in the private fund or similar pool of assets.
Additionally, the package included a new rule that requires ALL registered investment advisers to annually document, in writing, the required review of their compliance policies and procedures.
The compliance date of these rules will be either 12 or 18 months after publication in the Federal Register, with one notable exception – advisers will have only 60 days to comply with the requirement to document, in writing, their Annual Review. This means that for most advisers that complete their Annual Review in the fourth quarter, they will need to meet the requirements of the new rule.
Notably, two proposed provisions – the prohibition of fees for unperformed services and prohibitions against elimination or limitation of liability – were not adopted in the final rules. This change, combined with a new “legacy” provision that allows pre-existing agreements that include certain preferential treatment and restricted activities to remain in effect after the compliance date, largely eliminates the need for an industry-wide re-papering of advisory contracts, fund governing documents and investor agreements that many commenters had feared.
Other changes will have less impact. For example, the proposal prohibited certain preferential treatment of some investors, but the final rule allows this practice as long as the same terms are offered to all investors. Of course, if everyone must be offered the same terms, then preferential terms are prohibited.
COMPLY will continue to analyze this final rule in the coming days and will provide updated information as it develops.
Complying with the New SEC Rules
The breadth and depth of COMPLY’s capabilities – which encompass compliance technology solutions, consulting services and educational resources – will all be deployed to assist our thousands of private fund adviser customers in designing and implementing the required updates to their compliance programs. Whether you need advice from our regulatory consultants, a compliance program management tool, a disclosures management system or new compliance workflows, COMPLY can help.
Our technology platforms, which have long facilitated the documenting of the annual review, will be enhanced to support any new written documentation requirements mandated by the final rule, with features that include:
- A configurable calendar with robust content library and task management
- Policy and procedure creation and management
- An Annual Review tool that facilitates compliance policies and procedures testing and documentation
- A Risk Assessment module
COMPLY’s consulting and services are also well positioned to assist our customers with the annual review requirement. Our Regulatory Services group will deliver new consulting services and educational programs to assist advisers in completing and documenting a robust annual review.
Interested in learning more? Schedule a time to speak with an expert today!