On August 23, 2023, the Securities and Exchange Commission (SEC) adopted new rules and amendments to the Investment Advisers Act of 1940 that will significantly impact both registered and non-registered investment advisers, but specifically advisers of private funds. Below highlights the primary changes, when they take effect, and the short- and long-term impact on advisers and funds.
Private fund advisers registered with the SEC will be required to provide information about private fund fees, expenses and performance in the form of quarterly account statements. These statements must be produced within 45 days after each of the first three fiscal quarter-ends and 90 days after the fiscal year-end (75 and 120 days, respectively, for fund of funds).
The quarterly account statements would be required to disclose the following information in a table format:
Our Take >> There will be a significant amount of administrative time required to prepare the quarterly account statements. In addition, the quarterly account statements need to be turned around quickly to provide this information to investors. This could be a challenge to all private funds, but even more acute for private funds that have complex structures and need to value hard-to-value illiquid investments. Additional time and expense incurred to prepare these statements will be passed on to the investors.
All private funds advised by registered investment advisers will be required to have an annual audit and a liquidation audit:
Our Take >> Exemptions under the custody rule or otherwise will no longer help a fund avoid an audit requirement. In addition, these audits will need to be performed by auditors that are registered and inspected by the PCAOB, creating additional expenses investors must bear — likely with the greatest impact falling on smaller private funds. And for funds that have not been audited previously, this would impact expense ratios and performance on a prospective basis.
Registered investment advisers will need to obtain a fairness or valuation opinion for an adviser-led secondary transaction:
Our Take >> The SEC has made it clear that if a private fund adviser enters an adviser-led secondary transaction, it will be subject to scrutiny. Third-party service providers that provide fairness and valuation opinions will need to be vetted thoroughly. Going through this process will require the private fund adviser to have personnel to manage the fairness opinion process. This could put a strain on the private fund adviser’s employees and/or require retention of additional employees, impacting the adviser’s overall profitability. Additionally, the required written summary of any material business relationships could limit advisers’ choices in selecting a third-party service provider out of a desire to avoid additional time, expenses, and scrutiny from regulators and investors.
Our Take >> When it comes to running certain expenses through their private funds, the SEC has clearly signaled they will apply more scrutiny to this area. This also may impact a private fund adviser’s profitability, and advisers may assess higher management fees if they are prohibited from allocating certain expenses through the private funds. In addition, offering and governing documents will need to be revised to ensure they are specific in terms of the type of expenses that are charged to the fund to make it clear to regulators and investors. Expenses will also need to be referenced to the appropriate section of the governing documents on the quarterly account statement. Resources will be required to manage these changes and legal counsel will need to be consulted, representing additional time and expense. Lastly, auditors will likely need to spend more time auditing the expense areas and reviewing associated disclosure or consent notices to ensure compliance.
Private fund advisers also will no longer be able to allocate fees and expenses to their funds associated with an investigations or examinations without seeking consent from investors. This will significantly complicate investor communication logistics, increase consultations with legal counsel, and hamper timely finalization of accounting further complicated by the new 45-day deadline for more detailed quarterly investor statements.
Our Take >> Private fund advisers that continue to provide preferential redemption terms and/or information rights to certain investors will need to perform an analysis to ensure those rights do not negatively impact other investors. Advisers will be required to offer the same redemption ability to all current and future investors. This analysis could be difficult to determine in advance and could increase regulatory risk to advisers; they will have to weigh the cost/benefit. In addition, this could make negotiations with prospective investors more difficult and hinder an adviser’s ability to attract investors who require more flexible terms.
Should private fund advisers continue to have side letters that offer differing fee structures etc., related to any material economic terms, those terms would need to be disclosed to current and prospective investors. Determining the timing of disclosure and then engaging with the current and prospective investors will likely generate interesting discussions as to why there are differing terms. This will also likely cause additional time and expenses consulting with legal counsel, analysis of whether the terms have negative impact on other investors and discussing with current and prospective investors. This will also hinder new and smaller advisers’ ability to secure anchor investors with preferential rights.
All investment advisers registered with the SEC will need to document in writing the annual review of their compliance policies and procedures.
Our Take >> Written documentation of the annual compliance review will require additional resources to execute. This will likely add an additional level of regulatory time spent by the private fund adviser’s employees and/or require them to hire additional employees, ultimately impacting the private fund adviser’s profitability.
| New Private Fund Adviser Rule | Effective Date |
|---|---|
| Private Fund Audit Rule | 18 months after the date of publication in the Federal Register |
| Quarterly Statement Rule | 18 months after the date of publication in the Federal Register |
| Adviser-Led Secondary Transactions Rule | 12 months after the date of publication in the Federal Register for advisers with $1.5 billion or more in private funds assets under management (AUM) 18 months after the date of publication in the Federal Register for advisers with less than $1.5 billion in private funds AUM |
| Preferential Treatment and Restricted Activities Rules | 12 months after the date of publication in the Federal Register for advisers with $1.5 billion or more in private funds assets under management (AUM) 18 months after the date of publication in the Federal Register for advisers with less than $1.5 billion in private funds AUM |
| Compliance rules related to compliance policies and procedures | 60 days after the date of publication in the Federal Register |
There is a lot at stake for private fund advisers, especially new and small advisers. It will be important to consider the impact these regulations will have on their business during the implementation period and in the long-term.
Contact Keith Stafford at kstafford@cohenco.com or a member of your service team to discuss this topic further.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.