As expected, in a 3-2 vote, the SEC yesterday approved new Private Fund Adviser rules, made under the Investment Advisers Act of 1940, albeit with some helpful changes (including some limited grandfathering provisions) from those proposed in February 2022 (see our recap here).
At 660 pages, the SEC's Adopting Release is lengthy and its implications complex.
A high level summary of some of the key changes made in the final rules is set out below. We will be
providing more detailed analysis in due course and
holding a Hedge Fund Vista call soon to discuss the main implications of these changes for affected clients.
More details of this call will be made public shortly.
What's the timing on this?
The rules will come into force as follows
Private Fund Audit Rule and the Quarterly Statement Rule:
- 18 months after the date of publication in the Federal Register ('Publication').
Adviser-Led Secondaries Rule, the Preferential Treatment Rule and the Restricted Activities Rule:
for advisers with $1.5 billion or more in private funds AuM, 12 months after Publication and
for advisers with less than $1.5 billion in private funds AuM, 18 months after Publication.
Amended Advisers Act compliance rule:
- all registered advisers will be required to be in compliance 60 days after Publication.
Key changes made to the original proposals include:
Grandfathering provisions
There were no grandfathering (or 'legacy status') provisions contained in the SEC's original proposals, so their inclusion in the final rules (albeit in somewhat limited circumstances) is a positive move. These will apply as follows:
under the Preferential treatment rule
- to side letters (and other governing agreements), which would otherwise have been subject to amendment as a result of the rules. These can be grandfathered so long as
- these were in writing and had been entered into prior to the compliance date (see above) and
- the fund has already commenced operations as at the compliance date.
- to prohibitions on preferential redemption rights and information about portfolio holdings
under the Restricted activities rule
in respect of the rules requiring investor consent in respect of borrowing from a private fund and charging for certain investigation fees and expenses.
there will be no grandfathering for those parts of the restricted activities rule where the exemption requires only disclosure (and not investor consent)
Non-US Advisers and non-US Funds
The SEC notes that it does "not apply most of the substantive provisions of the Advisers Act with respect to non-U.S. clients of an SEC-registered offshore adviser".
Consistent with this approach, the Adopting Release states that "none of the final rules or amendments apply with respect to the offshore fund clients of an SEC-registered offshore adviser" (see the final sentence on page 48).
Prohibited activities
These have been renamed 'Restricted activities' in the SEC's final rules
A number of these activities, such as charging certain fees and expenses to the fund, will no longer be wholly prohibited but, instead, permitted so long as they have (in some cases) been disclosed to investors and (in other instances) disclosed to and been consented to by investors.
So, an adviser will not be able to
charge the private fund fees or expenses associated with an investigation of the adviser unless there has been both disclosure to investors and consent from a majority (in interest) of them (except where an investigation results in a court or governmental authority sanction for a violation of the Advisers Act, in which case there remains an outright prohibition against charging such fees or expenses).
charge the private fund the adviser's regulatory, examination, or compliance fees or expenses unless these have been disclosed in writing to investors no more than 45 days after the end of the fiscal quarter in which the charge occurs
charge the private fund fees related to a portfolio investment on a non-pro rata basis, unless the adviser distributes advance written notice of the non-pro rata charge and a description of how the allocation approach is fair and equitable and
borrow from a private fund client without prior disclosure to, and consent from a majority (in interest) of investors.
Preferential treatment
Changes to the proposed rules include:
There will no longer be a prohibition on indemnification of the private fund adviser by the private fund in the case of negligence
Some forms of preferential treatment regarding redemption rights and the sharing of information on the fund's portfolio holdings/exposures will now be permitted, though only in limited circumstances
There will be a prohibition on all private fund advisers from providing preferential terms to investors regarding redemptions from the fund where the adviser reasonably expects these terms would have a material, negative effect on other investors in the private fund or in a similar pool of assets. Such terms, though, may be provided where
the law, rules or regulations to which the investor or private fund is subject requires the investor to be able to redeem or
the same terms have been offered to all existing investors and will be offered to all future investors in the private fund.
There will be a prohibition on all private fund advisers providing information on the private fund's portfolio holdings/exposures where the adviser reasonably expects that providing this information would have a material, negative effect on other investors in that private fund.
However, again, this will be permitted where such preferential information is offered to all other existing investors in the private fund at the same, or substantially the same, time.
All private fund advisers will have to distribute to the fund's investors written notice of all preferential treatment provided by the adviser to other investors. This must be done, in the case of
a liquid fund - as soon as practicable after the investor has invested in the private fund
an illiquid fund - as soon as practicable after the end of the fund's fundraising period.
Adviser-led secondary transactions
Advisers will be able to choose to provide either a fairness opinion "or a valuation opinion" from an independent opinion provider (in the proposed rules, the valuation opinion was not an option).
