SEC Adopts Extensive New Regulation of Private Fund Advisers

The SEC adopted significant new regulation of private fund advisers under the Advisers Act, as well as other requirements that apply to all SEC-registered investment advisers.

The final rules include a number of modifications to the original proposal. The new rules require the following:

• Quarterly Statement Rule. SEC-registered private fund advisers are required to distribute a quarterly statement to private fund investors. The statement must provide information concerning fund performance, fund expenses and payments to the adviser. There are different requirements for liquid funds versus illiquid funds, with the difference in treatment based on the ability of investors to redeem.
• The Audit Rule. SEC-registered private fund advisers are required to have the funds that they advise obtain an annual audit in compliance with the requirements of Rule 206(4)-2 ("Custody of Funds or Securities of Clients by Investment Advisers").
• The Adviser-led Secondaries Rule. SEC-registered private fund advisers must obtain either a fairness opinion or a valuation opinion when offering existing fund investors the option between selling their interests in a private fund and converting or exchanging their interests in the private fund for interests in another vehicle advised by the adviser or any of its related persons.
• Preferential Treatment Rule. All private fund advisers are subject to a general restriction on providing preferential treatment to investors with regard to either redemptions or information as to fund holdings, subject to very limited exceptions and to investor- disclosure requirements. This requirement is subject to a "legacy" exemption to the extent that the relevant agreements have been entered into before the rule's compliance date.
• Restricted Activities Rule. All private fund advisers are prohibited from charging a variety of regulatory, litigation or investigation expenses related to the adviser back to the fund, subject to various conditions. Advisers are subject to restrictions as to the allocation of deal expenses. Advisers can not borrow from or lend to a fund without consent from fund investors. This restricted activities rule is also subject to a legacy exception.
• Compliance Rule. All registered advisers, including those who do not advise private funds, are required to document their annual review of their compliance policies.

The requirement as to documentation of compliance procedures will take effect 60 days after publication in the Federal Register. The other rules take effect either 18 months or 12 months after such date, depending on the rule and the size of the fund. Investment advisers to securitized asset funds are subject only to the Compliance Rule.

Commissioner Statements:

• SEC Chair Gary Gensler stated that the final regulations "promote greater competition and thereby efficiency" in the private funds market. He noted that the final rules incorporated public feedback on the proposal, including (i) allowing more flexibility to offer preferential treatment, (ii) adding a legacy provision regarding preferential treatment and restricted activities and (iii) allowing advisers to satisfy the annual audit requirement by complying with the current custody rule.
• SEC Commissioner Caroline A. Crenshaw applauded the final regulations for "recalibrat[ing] the baseline for private fund investor disclosures and build[ing] guardrails around certain highly conflicted transactions."
• SEC Commissioner Jaime Lizárraga stated that by "reforming oversight of current practices" for investment advisers, the SEC is "level[ing] the playing field for investors of all sizes." He said that the final regulations will also provide more information for investors to make decisions by addressing "opaque and anti-competitive practices."
• SEC Commissioner Mark T. Uyeda argued that the final regulations are "arbitrary and capricious" and that they impose requirements that are "far more burdensome and restrictive" for sophisticated investors than products for retail investors. He also criticized the final regulations for relying on "questionable statutory authority" and failing to consider the aggregate impact of the other regulations proposed in the past year.

For a fuller discussion on the rulemaking, please see the Fried Frank memorandum authored by Jessica Forbes, Jonathan W. Rash, Joanna Rosenberg and Michael L. Sherman.