SEC Approves New Rules Impacting Investment Advisers and Funds
On Wednesday, August 23, 2023, the Securities and Exchange Commission (SEC) voted 3-2 along party lines to approve new rules and rule amendments under the Investment Advisers Act of 1940 (Advisers Act). The Final Rule imposes significant new requirements on investment advisers, including advisers to private equity funds and hedge funds.
In the SEC’s press release, the SEC explained that:
“[t]he new rules and amendments are designed to protect private fund investors by increasing transparency, competition, and efficiency in the private funds market.”
As noted by the SEC in the Final Rule, investment advisers’ private fund assets under management have increased from $9.8 trillion in 2012 to $26.2 trillion in 2022, with many individuals who would not qualify as “qualified investors” having:
“indirect exposure to private funds through those individuals’ participation in public and private pension plans, endowments, foundations, and certain other retirement plans, which all invest directly in private funds.”
Since the original rules were proposed by the SEC in February 2022, representatives of hedge funds, private-equity firms and venture-capital funds have lobbied the SEC and members of Congress against the rulemaking. Although the SEC ultimately decided to abandon some of the most onerous regulatory burdens originally proposed last year, the new requirements are still significant, and investment advisers will need to carefully review the Final Rule to ensure such advisers are in compliance.
Changes for Registered Private Fund Advisers
With respect to private fund advisers registered with the SEC, the Final Rule imposes the following new requirements:
Quarterly Statement Rule
Registered private fund advisers must prepare a quarterly statement that includes certain information regarding fees, expenses, and performance for any private fund that such advisers advise and distribute such statements to the private fund’s investors, unless a quarterly statement that complies with the rule is prepared and distributed by another person.
Audit Rule
Registered private fund advisers must obtain an annual financial statement audit from an independent public accountant of the private funds such advisers advise.
Adviser-Led Secondaries Rule
If registered private fund advisers initiate a transaction that offers fund investors the option between selling all or a portion of their interests in the private fund and converting or exchanging them for new interests in another vehicle advised by the adviser or any of its related persons, the advisers must:
- Obtain a fairness opinion or a valuation opinion from an independent opinion provider and distribute the opinion to private fund investors prior to the due date of the election form; and
- Prepare and distribute a written summary of any material business relationships between the adviser or its related persons and the opinion provider.
Changes for All Private Fund Advisers
With respect to all private fund advisers, the Final Rule imposes the following new requirements:
Restricted Activities Rule
Private fund advisers cannot engage in any of the following activities unless such advisers satisfy certain disclosure requirements and, in some cases, consent requirements:
- Charging or allocating to the private fund fees or expenses associated with an investigation of the adviser or its related persons by any governmental or regulatory authority (and regardless of any disclosure or consent, an adviser may not charge or allocate fees and expenses related to an investigation that results or has resulted in a court or governmental authority imposing a sanction for violating the Advisers Act or the rules promulgated thereunder);
- Charging the private fund for any regulatory, examination, or compliance fees or expenses of the adviser or its related persons.
- 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.
- Charging or allocating fees and expenses related to a portfolio investment on a non-pro rata basis when more than one private fund or other client advised by the adviser or its related persons have invested in the same portfolio company.
- Borrowing money, securities, or other private fund assets, or receiving a loan or extension of credit, from a private fund client.
Preferential Treatment Rule
The Final Rule prohibits private fund advisers from doing any of the following, including through side letters:
- Granting an investor the ability to redeem its interest on terms that the adviser reasonably expects to have a material, negative effect on other investors, except for (i) redemptions required by applicable law, rule, regulation or order of certain governmental authorities and (ii) if the adviser has offered the same redemption ability to all existing investors and will continue to offer the same redemption ability to all future investors;
- Providing information regarding portfolio holdings or exposures to any investor if the adviser reasonably expects that providing the information would have a material, negative effect on other investors, except where the adviser offers such information to all other existing investors at the same time or substantially the same time; and
- Providing any other preferential treatment to any investor in the private fund unless the adviser delivers (i) advanced written disclosures to prospective investors regarding the material economic terms the adviser or its related persons provide to other investors in the same fund and (ii) comprehensive, annual disclosures to current investors of all preferential treatment provided by the adviser or its related persons since the last annual notice.
With respect to all registered investment advisers, the Final Rule requires such advisers to document in writing their annual review of their compliance policies and procedures.
The Final Rule provides that the Quarterly Statement Rule, Audit Rule, Adviser-Led Secondaries Rule, Restricted Activities Rule, and Preferential Treatment Rule do not apply to investment advisers with respect to the securitized asset funds they advise.
Compliance Timeline
The Final Rule will be effective 60 days after publication in the Federal Register, and advisers must be in compliance with new rules and rule amendments as set forth in the table below.
| Rule | Compliance Date |
| Quarterly Statement Rule | 18 months after the date of publication in the Federal Register |
| Audit Rule | 18 months after the date of publication in the Federal Register |
| Adviser-Led Secondaries Rule | 12 months after the date of publication in the Federal Register for advisers with $1.5 billion or more in private fund assets under management and 18 months after the date of publication in the Federal Register for advisers with less than $1.5 billion in private fund assets under management |
| Restricted Activities Rule | 12 months after the date of publication in the Federal Register for advisers with $1.5 billion or more in private fund assets under management and 18 months after the date of publication in the Federal Register for advisers with less than $1.5 billion in private fund assets under management |
| Preferential Treatment Rule | 12 months after the date of publication in the Federal Register for advisers with $1.5 billion or more in private fund assets under management and 18 months after the date of publication in the Federal Register for advisers with less than $1.5 billion in private fund assets under management |
| Documentation of Annual Review of Compliance Policies and Procedures | 60 days after the date of publication in the Federal Register |
Legacy Status and Additional Considerations
Please note, however, that in a significant deviation from the SEC’s originally proposed rule, the Final Rule provides “legacy status” (or grandfathering) for the prohibitions provisions of the preferential treatment rule and for the provisions of the restricted activities rule requiring investor consent. The legacy status provisions apply to any governing agreement that was entered into prior to the compliance date if the rule would require the parties to amend such agreement.
New and existing investment advisers should carefully consider the impact of these new rules and rule amendments on their practices. For more information, please contact Andrew Wilber (AJW@kjk.com; 216.736.7298) or Christopher Hubbert (CJH@kjk.com; 216.736.7215) or another member of our Private Equity practice group.