On August 23, the U.S. Securities and Exchange Commission ("SEC") voted 3-2 to finalize a package of rules and amendments under the Investment Advisers Act of 1940 (the "Advisers Act") that will significantly change the private funds industry (the “Adopting Release”).  The Adopting Release finalizes new rules and amendments that were proposed in February 2022 (the “Proposal”).  The SEC made meaningful changes in the Adopting Release that mitigated some of the most onerous effects of the new requirements and cited AIMA/ACC comments on 104 different occasions.  Nevertheless, significant concerns remained regarding the final wording of key clauses and how the new requirements will be applied in practice.  AIMA, along with a coalition of other trade associations, challenged the authority for these requirements in an appeal to the 5th Circuit Court of Appeals.  The mandate of the court vacating this rule was issued on July 29, 2024.  Compliance with the requirements in the Adopting Release is no longer required.

Information on Key Sections:

Restricted Activities ("Prohibited Activities" under the Proposal)

• The Adopting Release prohibits outright all private fund advisers from charging fees or expenses related to an investigation that results or has resulted in a court or governmental authority imposing a sanction for a violation of the Advisers Act.
• All private fund advisers also will be prohibited, unless either (i) disclosed to or (ii) disclosed to and consented to by investors, as applicable, from charging certain fees and expenses to the fund, e.g., an adviser may charge or allocate to the private fund fees or expenses associated with an investigation of the adviser by any governmental or regulatory authority, unless the adviser requests each investor of the private fund consents to such charge or allocation and obtains written consent from at least a majority in interest of the private fund’s investors, and provided the fees and expenses do not meet those outright prohibited (as above).  See the link to our initial high-level summary below for further details on how and what fees and expenses may be passed onto the private fund.  
• The Adopting Release did not include the proposed prohibition for charging for unperformed services, and it did not require a change to the liability standard from gross to simple negligence.  However, the Adopting Release does contain some discussion that suggests these requirements are not entirely gone.

Preferential Treatment

• The Adopting Release permits certain forms of preferential treatment regarding redemption rights and the sharing of information on the fund’s portfolio holdings/exposures (which the Proposal would have prohibited outright) if the requirements of one of the limited exceptions are satisfied.
• The new rule requires the private fund adviser to provide to any prospective investor in the private fund, prior to the investor’s investment in the private fund, a written notice regarding specific information that pertains to preferential treatment related to any material economic terms that the adviser provides to other investors in the same private fund.
• In a change from the Proposal, all private fund advisers will be required to distribute to current investors a written notice of all preferential treatment the adviser or its related persons has provided to other investors in: (i) a liquid fund as soon as reasonably practicable following the investor’s investment in the private fund; or (ii) an illiquid fund as soon as reasonably practicable following the end of the fund's fundraising period.
• As proposed, all private fund advisers will be required to provide current investors comprehensive, annual disclosure of all preferential treatment provided by the adviser or its related persons since the last annual notice.

Adviser-led Secondary Transactions

• The Proposal would have required registered investment advisers to private funds to obtain and distribute to investors a fairness opinion from an independent opinion provider along with a summary of any business relationships with the opinion provider.  Tender offers would have qualified as adviser-led secondary transactions under the Proposal.
• Consistent with our recommendation, the final rule allows registered investment advisers to provide either a fairness opinion or a less expensive valuation opinion from an independent opinion provider and excludes tender offers from the scope of adviser-led secondary transactions.

Private Fund Audits

• The Adopting Release harmonizes this annual audit requirement with the audit provisions established in the custody rule that are applicable to pooled investment vehicles.  Because compliance with the new rule is in part predicated on an adviser complying with the current custody rule’s audit provision, the proposed modifications to the audit provision in the proposed amendments to the custody rule (i.e., the Safeguarding Rule issued in February 2023) would also apply to advisers subject to the private fund audit requirements.
• Accordingly, the SEC has reopened the comment period for the Safeguarding Rule so that commenters may consider the proposed modifications to the audit provisions vis-à-vis the new private fund audit rule.

Quarterly Statements

• For illiquid funds, the Proposal would have required calculation of performance only without the impact of subscription facilities. However, the Adopting Release allows calculation of performance both with and without the impact of subscription facilities, rather than only without.  The Adopting Release refined the definition of an illiquid fund to be based primarily on withdrawal and redemption capability.
• The Adopting Release, in a change from the Proposal, limits the required lookback period to 10 years for advisers to present liquid fund performance.
• The Proposal required registered investment advisers to distribute the required quarterly reports within 45 days of each calendar quarter.  The Adopting Release adds more time for fourth quarter reports (90 days rather than 45) and for reports by funds of funds (75 days for the first three quarters and 120 for the fourth quarter).  The reporting requirement for any private fund was also changed from two full calendar quarters of operating to two full fiscal quarters of operating.

Compliance Program Rule

• As proposed, all registered investment advisers (including those that do not advise private funds), will be required to document in writing the annual review of their compliance policies and procedures required by the compliance program rule.

Grandfathering

• The Proposal offered no grandfathering, but the Adopting Release offers “legacy status” (i.e., grandfathering), although the coverage may be incomplete and lead to some disparate outcomes.
• Legacy status was given for the prohibitions aspect of the preferential treatment rule (i.e., preferential redemption rights and information about portfolio holdings) and for aspects of the five restricted activities rule requiring investor consent (i.e., restrictions on borrowing from a private fund and from charging for certain investigation fees and expenses).
• Legacy status provisions apply to “governing agreements” (which include side letters) that were in writing and entered into prior to the compliance date if the rule would require the parties to amend such an agreement and only if the fund has already commenced operations (includes any bona fide activity directed towards operating a private fund, including investment, fundraising or operational activity) as of the compliance date.
• Legacy status will not apply to the disclosure portions of the preferential treatment rule or to the aspects of the restricted activities rule bearing only disclosure-based exceptions.

Treatment of Non-U.S. Advisers and Funds

• The quarterly statement rule, audit rule and adviser-led secondaries rule “will not apply to the non-U.S. private fund clients of an SEC-registered offshore adviser (regardless of whether they have U.S. investors).”
• The restricted activities requirements and preferential treatments requirements will apply to all advisers regardless of their registration status – i.e., they will apply to registered investment advisers and any adviser relying on an exemption from the requirement to register.  However, there are two major caveats:
  • Consistent with the Proposal, the restricted activities rule and the preferential treatment rule “would not apply with respect to a registered offshore adviser’s non-U.S. private funds, regardless of whether they have U.S. investors.”
  • According to the Adopting Release, the restricted activities rule and the preferential treatment rule “do not apply to offshore unregistered advisers with respect to their offshore funds (regardless of whether the funds have U.S. investors),” despite those rules generally applying to exempt advisers. 

An analysis of the application of the PFA Rules to non-U.S. advisers can be accessed here.

Compliance Dates/Transition Periods 

• The compliance program rule amendments will be required from November 13, 2023.
• Compliance with the private fund audit rule and the quarterly statement rule will be required for all private fund advisers from March 14, 2025.
• Compliance with the adviser-led secondaries rule, the preferential treatment rule and the restricted activities rule will vary between small and large advisers
  • Small advisers (Less than $1.5 billion of private fund RAUM):  from March 14, 2025.
  • Large advisers ($1.5 billion or more of private fund RAUM):  from September 14, 2024.

If you would like to read more about the Adopting Release, you can access our initial high-level summary here.  We have also summarized the requirements in much greater depth with the summary for registereed investment advisers available here and the version for private fund advisers exempt from SEC registration available here. 

Please contact Jennifer Wood with any questions regarding these requirements or the opinion of the 5th Circuit Court of Appeals.

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  Jennifer Wood

  Managing Director, Global Head of Asset Management Regulation & Sound Practices