SEC Proposes Extensive Rule Changes For Private Fund Advisers – Finance and Banking

Marion Steward

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On February 9, 2022, the Securities and Exchange Commission
(SEC) proposed new rules and amendments under the Investment
Advisers Act of 1940 (Advisers Act) to enhance the regulation of
private fund advisers.  The proposed new rules are intended to
provide additional protection for private fund investors by
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.  If
these proposed rules are adopted, private fund advisers will need
to adopt policies and procedures to comply with the new
requirements, which will impact private fund operations and
accounting processes and may require significant changes to
governing documents, offering memoranda and side letters. The
proposed rules are open for public comment until the later of (i)
30 days from publication in the Federal Register and (ii) 60 days
from February 9, 2022.  We note that this time period for
public comments is relatively short given the extensive nature of
the proposed rules.

The full text of the proposed rules can be found here
Below is a brief summary of the proposed new rules:

Quarterly Reporting

Under the proposed rules, any private fund adviser registered
with the SEC would be required to prepare quarterly statements
detailing information about fees, expenses and performance for any
private fund that it advises (directly or indirectly) and
distribute such quarterly statement to the private fund’s
investors within 45 days after each calendar quarter end, unless a
quarterly statement that complies with the proposed rule is
prepared and distributed by another person.  

Mandatory Annual Audit

Registered private fund advisers would be required to obtain an
annual audit for each private fund that it advises (directly or
indirectly) and distribute the audited financial statements to
investors “promptly” after the audit’s
completion.  Additionally, the proposed rule would require an
adviser to enter into, or cause the private fund to enter into, a
written agreement with the independent public accountant performing
the audit to notify the SEC (1) promptly upon issuing an audit
report to the private fund that contains a modified opinion and (2)
within 4 business days of resignation or dismissal from, or other
termination of, the engagement, or upon removing itself or being
removed from consideration for being reappointed.

Adviser-led Secondary Transactions

In connection with an adviser-led secondary transaction, the
proposed rules would require registered private fund advisers to
distribute to investors a written opinion stating the price being
offered is fair and a written summary of certain material business
relationships between the adviser and the opinion provider.
 As defined in the proposed rule, “adviser-led secondary
transactions” are transactions initiated by the investment
adviser or any of its related persons that offer a private
fund’s investors the choice to (1) sell all or a portion of
their interests in the private fund; or (2) convert or exchange all
or a portion of their interests in the private fund for interests
in another vehicle advised by the adviser or any of its related

Prohibited Activities

The proposed rules would also prohibit all private fund
advisers, including those that are not registered with the SEC or
pursuant to state law, exempt reporting advisers and persons
prohibited from registration, from engaging in certain activities
and practices that are contrary to the public interest and the
protection of investors.  Such activities include (1) reducing
any adviser clawback by the amount of certain taxes, (2) seeking
reimbursement, indemnification, exculpation or limitation of the
adviser’s liability by the private fund or its investors for
breach of fiduciary duty, willful misfeasance, bad faith,
negligence, or recklessness in providing services to the private
fund, and (3) borrowing money, securities or other fund assets, or
receiving an extension of credit, from a private fund client.
 The proposed rule would also prohibit an adviser from
charging certain fees or expenses to a private fund or portfolio
investment, including, for example, fees and expenses associated
with an examination or investigation of the adviser or its related
persons by any governmental or regulatory body, and regulatory or
compliance fees and expenses of the adviser or its related persons,
even where such fees and expenses are otherwise disclosed.

Prohibition of Preferential Treatment

All private fund advisers, including those that are not
registered with the SEC or pursuant to state law, exempt reporting
advisers and persons prohibited from registration, would be
prohibited from providing preferential terms to certain investors
regarding liquidity rights or information about portfolio holdings
or exposures.  The proposed rule would also prohibit these
advisers from providing any other preferential treatment to any
investor in the private fund unless the adviser provides written
disclosures to prospective and current investors in the private
fund regarding all preferential treatment the adviser or its
related persons are providing to other investors in the same

Under the proposed rule, an adviser would need to describe
specifically the preferential treatment to convey its
relevance.  For example, if an adviser provides an investor
with lower fee terms in exchange for a significantly higher capital
contribution than paid by other investors, the SEC does not believe
that mere disclosure that some investors pay a lower fee is
specific enough.  Instead, the SEC believes an adviser must
describe the lower fee terms, including the applicable rate (or
range of rates if multiple investors pay such lower fees), in order
to provide specific information as required by the proposed rule.
To comply with this proposed rule, an adviser could provide copies
of side letters (with identifying information regarding the other
investors redacted) or provide a written summary that specifically
describes the preferential treatment. For prospective investors,
this disclosure must be provided, in writing, prior to the
investor’s investment, and for existing investors, the adviser
would have to distribute the notice annually if any preferential
treatment is provided to an investor since the last notice.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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