The Securities and Exchange Commission adopted new rules and amendments to the Advisers Act of 1940 on August 23, 2023, aimed at tightening the regulation of private fund advisers, especially at private equity and hedge funds, and updating an existing rule that applies to all investment advisers.
The new rules are a significant expansion of the SEC’s regulation of private fund advisers. It is anticipated that the rules will change how private fund advisers and investors in private funds— institutional investors, pension plans, and high-net-worth individuals— will structure their relationships. The Rules will create substantive compliance and reporting requirements that are more detailed and potentially more burdensome than what is currently required from registered advisers to funds that are subject to registration under the Investment Company Act of 1940 and certain other private fund advisors.
Generally, the focus of the new rules is to require funds to disclose more information about their fees and certain expenses, as well as require quarterly financial disclosures and annual financial statement audits for each fund they advise to be distributed to investors. The purpose of the audits is to provide a check on the advisor’s valuation of private fund assets and protect private fund investors against the misappropriation of fund assets.
SEC registered private fund advisors will be required to: (1) prepare and distribute quarterly statements disclosing information on fund performance, fees and expenses, as well as certain compensation or other amounts paid to the adviser; (2) obtain an annual audit by an independent public accountant for each private fund they manage; and (3) distribute to investors a fairness opinion or a valuation opinion in connection with adviser-led secondary transactions and disclose certain material relationships between the adviser and the opinion provider. A change from the original proposal, registered and unregistered advisers will not be absolutely prohibited from charging various fees and expenses in various enumerated circumstances. Registered and unregistered advisers are, however, prohibited from engaging in certain types of preferential treatment of investors that have a material negative effect on other investors unless certain exceptions are met.
The SEC did not adopt the proposed prohibition on the adviser seeking reimbursement, indemnification, exculpation or limitation of liability for the adviser’s breach of fiduciary duty, willful malfeasance, bad faith, negligence, or recklessness in providing services to a private fund. Also, the SEC did not adopt the proposed prohibition on charging fees for unperformed services, under the premise that such a practice is already inconsistent with an adviser’s fiduciary duty.
Generally compliance with these rules will begin 18 months after publication in the Federal Register, except for the amendments to the Advisers Act which have to be complied within 60 days after publication in the Federal Register.
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