In 2023, the Securities and Exchange Commission (SEC) finalized new rules for private fund advisers, aiming to provide further protection to investors.
A big piece of the new requirement is that all investment advisers (including private fund advisers) will now need to annually document a review of their compliance policies and procedures in writing.
Today, we’re taking a look at some of the other compliance updates provided by the rule, including seven must-know requirements for private fund advisers.
A note on exempt reporting advisers
Investment advisers (including private equity advisers) are generally required to register with the SEC. There are, however, certain exemptions that apply.
For example, private fund advisers that have less than $150 million in AUM need not register – and thus some of the following rules in this list may not apply. However, it should be noted that this applies exclusively to firms that ONLY advise a private fund (or more than one) but does not provide retail or SMA advice.
Keep in mind that even if your firm is exempt from SEC registration, you may still need to comply with specific federal reporting and compliance requirements.
This isn’t a new stipulation, but it’s important to keep in mind as some of the new rules below apply only to SEC-registered private fund advisers.
Seven recent must-knows about private equity compliance
With that in mind, let’s dive into some of the key must-know requirements for private fund advisers.
1. Private fund advisers must provide performance reports to investors on a quarterly basis.
Per the new rules, SEC-registered private fund advisers are now required to provide quarterly statements to their clients each quarter.
These statements must include fund- or portfolio-level performance details, as well as any fees incurred. Advisers will also need to include costs or compensation paid to them (or related parties) by the client.
Reports are due within 45 days of the end of the quarter, although advisers are given a 90-day window at the end of each fiscal year for that quarter’s report.
Related: Moving out of Excel: A private equity firm’s compliance transformation
2. Private fund firms must be audited each year via a public accountant.
Many firms wonder when the SEC will come knocking for a compliance examination – but for registered private fund advisers, accounting audits will now be a regular occurrence.
The recently adopted rules require SEC-registered firms to hire an independent public accountant – who is registered with the Public Company Accounting Oversight Board (PCAOB) – to audit each private fund within their care.
Advisers are then given 120 days from the end of the fiscal year to distribute the audit statements to each of their clients.
3. There are new disclosure requirements for investigation- and compliance-related expenses.
New disclosure requirements apply to all private fund advisers – whether they’re SEC-registered or not.
Firstly, in the event that you are investigated, you must disclose and gain consent from investors to charge or allocate any associated fees or expenses to their private fund. While all investors must receive such a disclosure, only the majority of investors must provide consent.
If the investigation results in a sanction for a violation of the Investment Advisers Act of 1940, the charges and allocations are completely prohibited.
Similarly, advisers must now disclose to investors if any charges or allocations of their private fund are used for regulatory, examination or compliance fees. This requirement applies to the adviser’s associates as well, and the disclosures will need to be distributed on a quarterly basis.
4. Private fund advisers must disclose certain tax clawbacks.
As a quick refresh, a tax clawback occurs when tax benefits are reinvested into the private fund to cover for any cash shortages.
Moving forward, private fund advisers will need to disclose those clawbacks (including both the pre-tax and post-tax amounts).
Note that while the original rule amendment proposed a total prohibition of “reducing the amount of any adviser clawback by actual, potential or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders,” the final rule still allows it in certain cases, assuming you satisfy the disclosure requirements.
5. Private fund advisers are required to disclose and gain consent from investors before borrowing or receiving credit from a private fund.
The updated rule states that private fund advisers must disclose any extension of credit from a private fund to the investor before borrowing or receiving such funds. Advisers will also need to gain written consent from the majority of affected investors.
Note that the disclosure must include any and all material terms of the credit arrangement.
6. Preferential treatment between investors is not allowed.
The SEC writes:
“Private fund investors may not, directly or indirectly… grant an investor in the private fund or in a similar pool of assets the ability to redeem its interest on terms that the adviser reasonably expects to have a material, negative effect on other investors in that private fund or in a similar pool of assets.”
However, the key exception to this rule is that advisers may do so if they continuously offer the same terms and information to all investors in the private fund or similar pool of assets.
7. Private fund advisers must provide written notice of fee and expense allocation to portfolio investments.
One last update to keep in mind from the new rule is that any non-pro rata fee and expense allocations will need to be disclosed to investors via an advanced, written notice. These notices should also include a description of how the allocation is fair and equitable.
As a reminder, the above list isn’t by any means exhaustive of private equity compliance, or even of the newly adopted rules. It is, however, a great starting point for advisers looking to stay on top of new regulatory requirements moving forward.
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