SEC proposes new rules for private fund managers
The Securities and Exchange Commission (“SEC”) today proposed a series of new rules and amendments to existing rules (the “proposed rules”) under the Investment Advisers Act of 1940 (the “Advisors Act”) applicable to private fund managers. The proposed rules seek to, among other things: (i) require accurate and standardized quarterly disclosures regarding performance, fees and expenses, (ii) prohibit private fund managers from engaging in certain activities, (iii) require disclosure and, in some cases, limiting, preferential treatment given to certain private fund investors, (iv) requiring all private funds to be subject to an annual audit, (v) adding a written documentation requirement for annual reviews and (vi) create requirements to keep records of compliance with the Rules Project. Some of the proposed rules apply only to SEC-registered private fund investment advisers (“registered advisers”) and others apply to all private fund investment advisers (“private fund advisers”). , even when those private fund advisers are not SEC-registered.
Rule of quarterly statements. The proposed rules would require registered advisers to distribute to investors a quarterly statement for each private fund within 45 days of the end of the calendar quarter. These statements must include the following items relating to the private fund for the applicable reporting period:
- a detailed record of all compensation, fees and other amounts awarded or paid to the Registered Advisor or any of its Related Persons, with separate line items for each category of award or payment (e.g., management, sub-advisor , performance-based compensation, fees or similar payments);
- a detailed accounting of all fees and expenses paid during the reporting period, with separate line items for each category of expenses (e.g. organizational, accounting, legal, administrative, audit, tax, due diligence, trip) ;
- for each portfolio investment that paid compensation to the registered adviser or its related persons during that quarter, a detailed statement of such compensation and the applicable percentage of fund ownership of the portfolio investment;
- conspicuous information on the methods of calculating all expenses, payments, allowances, rebates, waivers, and offsets, including references to the private fund’s organizing and offering documents; and
- performance information calculated using the methodologies specified in the proposed rule, with the performance measures required being different for “liquid” and “illiquid” funds.
Prohibited Activities Rule. The proposed rules prohibit all private fund advisers (including non-SEC registered advisers) from engaging in certain specified activities. These prohibitions would apply whether or not the private fund’s governing documents authorize such activities, including where investors have given express or implied consent to such activities. Private Fund Advisers, with respect to a private fund or any investor in a private fund, would be prohibited from:
- seek reimbursement, indemnification, exoneration or limitation of liability of the Private Fund Advisor by the Private Fund or its investors for breach of fiduciary duty, willful misconduct, bad faith, negligence or recklessness in the provision of services to the private fund;
- charge the Private Fund for any fees or expenses associated with (i) any review or investigation of the Private Fund Advisor or its Related Persons by any governmental or regulatory authority, or (ii) any regulatory or compliance fees or expenses of the Private Fund Advisor; private fund or its related persons;
- reduce the amount of any Advisor’s recapture by actual, potential or hypothetical taxes applicable to the Private Fund Advisor, its related persons or their respective owners or interest holders;
- charge or allocate fees and expenses related to a portfolio investment (or potential portfolio investment) on a disproportionate basis where multiple private funds and other clients advised by the private funds adviser or its related persons have invested (or propose to invest) in the same portfolio investment;
- charge a Portfolio Investment supervisory, management, advisory or other fees for any service that the Investment Adviser does not provide or does not reasonably expect to provide to the Portfolio Investment; and
- borrow money, securities or other private fund assets, or receive a loan or extension of credit, from a private fund client.
Preferential treatment rule. The proposed rules would prohibit all private fund advisers (including non-SEC-registered advisers) from granting certain forms of preferential treatment to investors in a private fund and would require disclosure of all other types of preferential treatment. given to investors. Private Fund Advisers would be prohibited from:
- grant to an investor in a private fund or “substantially similar pool of assets” the ability to redeem its interests on terms that the Private Fund Advisor reasonably expects to have a material adverse effect on other investors in that Private Fund or a substantially similar set of assets; and
- provide information regarding the portfolio holdings or exposures of a private fund, or substantially similar pool of assets, if the private fund adviser reasonably expects the provision of such information to have an adverse effect important to other investors in this private fund.
The proposed rules would also require private fund advisers to specifically disclose any other preferential treatment given to an investor in a private fund to all potential and current investors in that fund. This written information must be provided to potential investors in writing prior to their investment, and an annual notice describing the preferential treatment granted must be provided to all existing investors.
Private Funds Audit Rule. The proposed rules would require registered advisers to obtain an audit of the financial statements from an independent public accountant for each private fund they advise at least once a year and upon winding up. Although an annual audit conducted in accordance with Rule 206(4)-2 of the Advisers Act (the “Custody Rule”) will in many cases satisfy the conditions of the Proposed Rules, compliance with the Custody Rule n is not sufficient to satisfy the proposed rules (or vice versa). The Proposed Rules differ from the Custody Rule audit approach in some key respects, including, among others:
- annual audits are required for a private fund client even if the registered advisor gets a surprise review;
- the auditor’s engagement letters must require the auditor to notify the SEC’s review division of the auditor’s termination or issuance of a modified opinion;
- audited financial statements should be distributed to investors “promptly” after the audit is completed, and not necessarily within 120 days of the fund’s fiscal year-end (please note that private fund managers who rely on the audit approach under the Custody Rule would still need to comply with the distribution timing requirements of the Custody Rule);
- the proposed rules do not provide an exception to the audit requirement for the deduction of fees or where the adviser has custody solely because a person related to the custody of a client’s funds or securities (such as c is the case for the guard rule); and
- Registered advisers who do not control, are not controlled by, and are not under common control with a private fund they advise (for example, certain sub-advisers) would be required to take all reasonable steps to ensure that the private fund is subject to a financial statement audit.
Advisor-led secondaries rule. The proposed rules would require a registered adviser who engages in an adviser-led secondary transaction for a private fund client to distribute to investors, prior to the completion of the transaction:
- a fairness opinion prepared by an independent opinion provider (i.e. an entity that provides fairness opinions as part of its business and that is not related to the registered adviser) and
- a written summary of any material business relationship within the last two years between the registered adviser and the independent opinion provider.
Changes to compliance rules. The proposed rules include amendments to Rule 206(4)-7 of the Advisers Act (the “Compliance Rule”) requiring annual reviews conducted under the Compliance Rule to be documented in writing.
Amendments to rules relating to books and records. The proposal includes changes to Rule 204-2 of the Advisers Act (the “Books and Records Rule”) that would require registered advisers to maintain records related to the proposed rules.