On August 23, 2023, the Securities and Exchange Commission (SEC) agreed on amendments to the Investment Advisers Act of 1940 (Advisers Act) in order to enhance regulation to private fund advisers and protect investors with the unprecedented growth in the investment class over the last decade as well as a perceived lack of transparency. According to McKinsey’s Global Private Markets Review (March 2023) total assets under management reached $11.7 trillion as of June 30, 2022, with an annual growth of 20% since 2017. This sweeping regulation marks the first significant change in regulation enacted since Dodd-Frank in 2010 to address the calls for increased scrutiny from investors and regulators.
The new rules require private funds advisers registered with the SEC to:
- Provide investors with quarterly financial statements inclusive of fund performance, fees and expenses
- Have an independent public accountant perform an annual audit in accordance with of each fund that the registered investment adviser (RIA) advises (regardless of size) within 120 days of the private fund’s fiscal year-end essentially ending the ability to perform a surprise custody exam requirement under the Custody Rule
- Obtain fairness or valuation opinions on any secondary transactions (offering existing investors to sell/convert/exchange their interest to another vehicle advised by the RIA)
- Amendments to the books and records rule for the SEC to assess compliance
The new rules also state that all private fund advisers are required to:
- Prohibit side letters in most cases that provide preferential treatment to certain investors unless explicitly disclosed and/or offered to all current and future investors
- Prohibit engaging in activities that are contrary to public interest and protection of investors unless explicitly disclosed an in some cases with investor consent
The SEC provided additional guidance on agreements that existed prior to the compliance date allowing preferential treatment and restricted activities rules granting them legacy status. Additionally, the quarterly statement, annual audit, adviser-led secondary, and preferential treatment rules do not apply to securitized asset funds.
The book and records rule compliance amendment goes into effect 60 days after publication. The annual audit and quarterly statement rule goes into effect 18 months after publication. The adviser-led secondary rule, preferential treatment rule, and restricted activities rule the compliance dates are the following:
- 12 months after publication in the Federal Register – Advisers with $1.5 billion or more AUM
- 18 months after publication in the Federal Register – Advisers with less than $1.5 billion AUM
Private fund advisers should familiarize themselves with the new rules and ensure timely compliance.