On August 23, 2023, the U.S. Securities and Exchange Commission ("SEC") adopted the Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews final rule (the "Final Rule"). According to the adopting release, these rules are designed to address several risks in the relationship between advisers with private funds and their investors, including a lack of transparency, conflicts of interest and lack of effective governance mechanisms for client disclosure, consent and oversight.
Scope and Impact of the Final Rule
The Final Rule adopts new rules and amendments under the U.S. Investment Advisers Act of 1940, as amended (the "Advisers Act") and it will require all private fund advisers, including certain exempt reporting advisers ("ERAs") to meet specific disclosure, consent and other requirements prior to engaging in certain "restricted" activities and granting certain preferential treatment to investors. The Final Rule will also require registered private fund advisers to (i) provide quarterly statements to investors with detailed fee, expense and performance information, (ii) perform annual financial statement audits of advised funds, and (iii) obtain a valuation or a fairness opinion in connection with adviser-led secondary transactions, among other requirements. Also, the Final Rule will require all registered private fund advisers to document annual compliance reviews in writing.
Private fund advisers are already scoping and assessing the potential impact of the Final Rule on their businesses and planning how to navigate the requirements of the Final Rule. Nuanced issues will surface, and market practice will evolve over the course of the next year, but the Final Rule will undoubtedly have a major impact on, and significantly increase compliance burdens for, private fund advisers. While the Final Rule will cause a significant shift in the regulatory landscape governing private fund advisers, these rules will not impact all private fund advisers equally (see "Covered Firms," "Legacy Status" and "Compliance Deadlines" below).
Covered Firms
As summarized in the table below, whether an adviser is subject to the Final Rule will generally depend on (i) the registration status of the adviser, (ii) whether the adviser is a U.S. or non-U.S. adviser and (iii) whether the adviser is managing a U.S. or non-U.S. private fund. In particular, some of the requirements of the Final Rule apply only to advisers registered or required to be registered under section 203 of the Investment Advisers Act of 1940 ("RIAs"), while others apply to all private fund advisers (including ERAs, state-regulated advisers, advisers exempt from registration pursuant to foreign private adviser exemption and advisers that are otherwise unregistered with the SEC), subject to important exceptions noted below.
Compliance Deadlines and Transition Periods
The rules are effective November 13, 2023. As outlined in the table below, private fund advisers are subject to different compliance deadlines for the new rules.
Legacy Status
The Final Rule allows for limited legacy status – exceptions for private funds in existence prior to compliance dates—for the prohibition aspects of (i) the Restricted Activities Rule that require investor consent (i.e., restrictions from borrowing from a private fund and from charging funds for certain investigation fees and expenses) and (ii) the Preferential Treatment Rule (i.e., redemption rights and information regarding portfolio holdings). As detailed below, private fund advisers must satisfy stringent, and in some cases unclear, conditions in order to achieve legacy status for existing contractual arrangements governing the funds that they manage.
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