August 25, 2023
On August 23, 2023, the U.S. Securities and Exchange Commission (the “SEC”) by a 3-2 vote adopted final rules (the “Final Rules”) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), which modify certain aspects of the rules initially proposed on February 9, 2022 (the “Proposed Rules”) and adopt others largely as proposed. The Final Rules reflect the SEC’s asserted goal of bringing “transparency” to the inner workings of private funds and their sponsors by restricting or requiring extensive disclosure of preferential treatment granted in side letters, as well as imposing numerous additional reporting and other compliance requirements.[1] While several of the Final Rules require further clarification, and industry practice will undoubtedly evolve as the Final Rules are further analyzed and, to the extent possible, implemented, the following table sets forth a high-level overview of key requirements and restrictions reflected in the Final Rules. Following the table is a Q&A addressing some of the most frequently asked questions sponsors and other industry participants have asked us. These materials are a general, initial summary and do not assess the legality of the Final Rules, which remain subject to potential challenge.
Private Funds Rules – Overview of Key Requirements and Restrictions
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Requirement or Restriction |
High-Level Observations |
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Preferential Treatment Rule (Disclosure Requirements): An adviser may not admit an investor into a fund unless it has provided advance disclosure of material economic terms granted preferentially to other investors, and must disclose all other preferential treatment “as soon as reasonably practicable” after the end of the fundraising period (for illiquid funds) or the investor’s investment (for liquid funds) and at least annually thereafter (if new preferential terms are granted since the last notice). |
As set forth below, this requirement fundamentally changes the rules of the game with respect to a fund’s typical MFN process and requires advance disclosure of material economic terms, including to those investors who are not entitled to elect them, and to those who would not typically see them (e.g., smaller investors who do not have side letters).Because the disclosure requirements apply to existing funds, older funds will need to disclose preferential treatment previously granted but not yet disclosed. |
Compliance Date: 12 months (Larger Advisers) 18 months (Smaller Advisers) Existing funds grandfathered? No. |
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Quarterly Statement Rule: Registered advisers must issue quarterly statements detailing information regarding fund-level performance; the costs of investing in the fund, including itemized fund fees and expenses; the impact of any offsets or fee waivers; and an itemized accounting of all amounts paid to the adviser or its related persons by each portfolio company. |
As set forth below, the requirement to show performance metrics for illiquid funds, both with and without the impact of fund-level subscription facilities, and to spell out clearly all fund-level and portfolio company-level special fees and expenses (e.g., monitoring fees) and provide a cross-reference to the section of the private fund’s organizational and offering documents setting forth the applicable calculation methodology with respect to each is extremely burdensome and could provide another basis for the SEC staff to review performance calculations and fee and expense allocations during exams. We also expect the timing deadlines for the quarter- and year-end statements to present significant operational challenges for sponsors. |
Compliance Date: 18 months (Larger and Smaller Advisers) Existing funds grandfathered? No |
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Private Fund Audit Rule: Registered advisers must obtain an annual audit for each private fund that meets the requirements of the audit provision in the Advisers Act custody rule (Rule 206(4)-2), and will no longer be able to opt out of the requirement using surprise examinations. |
Many private fund sponsors are already providing audited financial statements in compliance with the custody rule. Sponsors who opt out of this requirement in favor of surprise examinations will be affected. We note that the SEC has re-opened its comment period with respect to its proposal regarding safeguarding client assets to allow commenters to assess its interplay with the Private Fund Audit Rule. |
Compliance Date: 18 months (Larger and Smaller Advisers) Existing funds grandfathered? No |
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Adviser-Led Secondaries Rule: Registered advisers must obtain and distribute an independent… |
Read More: A Guide to Understanding the New Private Funds Rules