In a 3-2 vote on August 23, 2023, the Securities and Exchange Commission ("SEC" or "Commission") adopted five new rules under the Investment Advisers Act of 1940 (the "Advisers Act"), collectively called the "Private Fund Adviser Rules."

In adopting the rules, the SEC cites the main harms it has observed within the private fund industry as the opacity of private fund investments, the problems raised by certain conflicts of interest and the lack of governance mechanisms within private fund structures to address investor oversight.1

During the comment period, the SEC received extensive comments from a wide range of industry participants, many of whom largely opposed the additional requirements these rules, as proposed, would impose on private fund advisers and cited their concerns about the pernicious consequences these rules may have, especially as proposed.2

Key Differences From Proposed Rules

Differences from the SEC's proposed rules in February 2022 (the "Proposed Rules")3 include:

  • Elimination of Negligence Standard for Exculpation and Indemnification: As a result of significant industry pushback in the comment process, the SEC dropped its proposed prohibition on a private fund adviser's seeking reimbursement, indemnification, exculpation or limitation of liability by the private fund or its investors for a breach of fiduciary duty, willful misfeasance, bad faith, negligence or recklessness.
  • Elimination of Prohibition on Charging Fees for Services Not Provided: The SEC also dropped its proposed prohibition on charging a portfolio investment for fees with respect to services that the adviser does not provide, or reasonably expects to provide, to the portfolio investment.
  • Disclosure and Consent Rather Than Prohibitions: The SEC changed the remaining "Prohibited Activities" under the Proposed Rule to "Restricted Activities," which require either investor consent for some such activities (such as charging a private fund for fees or expenses associated with an investigation and borrowing from a private fund client) or detailed disclosure to investors for other such activities (such as charging the private fund with regulatory, examination or compliance fees or expenses, use and impact of "after-tax" clawbacks, and charging fees or expenses related to a portfolio investment on a non-pro rata basis), as further detailed below.
  • Changes to Quarterly Statements: The SEC made some changes to the Quarterly Statement Rule in response to comments: (i) advisers to illiquid funds are required to calculate performance information with and without the impact of fund-subscription facilities; (ii) the definition of "illiquid fund" is now based primarily on withdrawal and redemption capability; (iii) advisers are only required to present liquid fund performance for a 10-year lookback period as opposed to since inception; and (iv) additional time was provided for the delivery of fourth quarter statements (and the delivery of all statements for funds of funds).4
  • Grandfathering: Unlike the Proposed Rules, the final rules provide for grandfathering of private funds that commence their operations before the compliance date, solely for the prohibitions of the Preferential Treatment Rule and for activities under the Restricted Activities Rule that require investor consent. Additional details on grandfathering and compliance dates are below.
  • CLOs and Other Securitization Vehicles Are Now Excluded: Advisers will not be required to comply with the requirements of the final rules with respect to securitized asset funds such as collateralized loan obligations ("CLOs").

Summary of Final Rules

Rules Applicable to All Private Fund Advisers (including ERAs):

  • Restricted Activities Rule: Rule 211(h)(2)-1 was called the "Prohibited Activities Rule" in the Proposed Rules but is now called the "Restricted Activities Rule" to reflect the departure from the flat-out prohibitions of certain activities of private fund advisers, and it will now be subject to disclosure or consent exceptions.5
    • Prohibited activities subject to consent exceptions include:
      • Charging or allocating, to the private fund, fees or expenses associated with an investigation of the adviser is prohibited but is subject to a consent exception: the adviser seeks consent from all investors and obtains written consent from a majority in interest of the private fund's investors that are not related persons of the adviser.6 The caveat to this rule is that an adviser may not charge or allocate fees and expenses related to an investigation that results or has resulted in a court or governmental authority imposing a sanction for violating the Advisers Act.7
      • Borrowing or receiving an extension of credit from a private fund client is prohibited but subject to a disclosure and consent exception: (i) the adviser distributes a written notice and description of material terms of the borrowing to the private fund investors, and (ii) the adviser obtains written consent from at least a majority in interest of the private fund's investors that are not related persons of the adviser.8
    • Prohibited activities subject to disclosure exceptions include:
      • Charging or allocating, to the private fund, regulatory, examination or compliance fees or expenses of the adviser is prohibited but subject to a disclosure exception: the adviser distributes a written notice of any such fees or expenses and the resulting dollar amount to investors in writing on at least a quarterly basis.9
      • Reducing the amount of an after-tax adviser clawback by actual, potential or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders is prohibited but subject to a disclosure exception: the adviser distributes a written disclosure to the investors that sets forth the pre-tax and post-tax amount of the clawback within 45 days after the end of the fiscal quarter in which the adviser clawback occurs.10
      • Charging or allocating fees or expenses related to a portfolio investment on a non-pro rata basis when multiple funds and other clients advised by the adviser or its related persons have invested in the same portfolio investment is prohibited but subject to two exceptions, one of which is disclosure-based: (i) the allocation approach is fair and equitable, and (ii) the adviser distributes advance written notice of the non-pro rata charge and a description of how the allocation approach is fair and equitable under the circumstances.11

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Footnotes

1. Private Fund Advisers; Documentation of Registered Adviser Compliance; Advisers Act Release No. 6383, 16-19 (Aug. 23, 2023) ("Adopting Release"), https://www.sec.gov/files/rules/final/2023/ia-6383.pdf

2. Adopting Release at 627 (noting commenters expressed concern regarding numerous issues the imposition of the rules would raise, including the negative effects the rules may have on competition for private fund advisers).

3. Private Fund Advisers; Documentation of Registered Adviser Compliance Reviews; Advisers Act Release No. 5955 (Feb. 9, 2022), https://www.sec.gov/files/rules/proposed/2022/ia-5955.pdf.

4. Adopting Release at 22.

5. Id. at 25.

6. Id. at 236-37, 655-56.

7. Id.

8. Id. at 243-46.

9. Id. at 212.

10. Id. at 223.

11. Id. at 224-26.

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