The SEC’s new private fund adviser rules: Who’s affected and how to prepare

21 September 2023
In August 2023, the US Securities and Exchange Commission adopted new rules and amended others to enhance the regulation of private fund advisers. According to the SEC, the changes are “designed to protect private fund investors by increasing transparency, competition and efficiency in the private funds market.”

The new rules and amendments primarily affect registered investment advisors (RIAs) and those required to be registered with the SEC under the Investment Advisers Act of 1940 across all types of private funds, including private equity, real estate, hedge funds, venture capital, debt and other alternative investments.

The new rules for fund regulations are comprehensive, with the SEC's report spanning over 600 pages. In simple terms, they include but aren’t limited to:

  • Quarterly statements rule. Private fund advisers will need to provide investors with quarterly statements that include more detailed disclosure of certain information regarding fund fees, expenses and performance. This must be done to specific timelines each quarter, depending on the nature of the fund, with a breakdown of outgoings itemised into distinct categories. 
  • Private fund audit rule. Private fund advisers must obtain an annual audit for each fund they manage (excluding securitised asset funds). The exact date of the audit will likely correspond to each fund's fiscal year-end, though this could vary.
  • Preferential treatment rule. To better protect investors, private fund advisers will be prohibited from granting investors with preferential liquidity or redemption rights, and/or from providing preferential information rights related to portfolio holdings or exposures of a private fund, unless disclosed accordingly. Private fund advisers are also required to describe any material conflict of interest in relation to their advisory activities.
  • Adviser-led secondaries rule. Private fund advisers will now have to obtain and distribute a third-party fairness opinion or valuation opinion to all investors. This is a new requirement that will require engaging robust third-party evaluators to validate the appropriateness of the transaction prices.
  • Restricted activities rule. The final rules will restrict certain other private fund adviser activity that is contrary to the public interest and protecting investors. These limitations may necessitate changes in the private fund advisers’ procedures and operations to avoid non-compliant activities. 

As with the introduction or amendments to any regulation, the challenge for many managers is to work out not only if they are affected, but how they are affected and what actions they should take. Here, Vistra’s Marlyn Ramirez, director, real estate fund operations US, and Tanya Scott-Tomlin, chief compliance officer, answer some of the more pressing questions around the new rules.

Who will be affected by the new SEC rules?

Marlyn: All private fund advisers will be affected to some extent. Registered investment advisers will be affected by all of the new rules and amendments, while exempt reporting advisers, who have typically been exempt from some reporting requirements, will fall under the adviser-led secondaries rule and the restricted activities rule.

This is really important, because some exempt advisers may believe that the new rules don’t apply to them, only to realise later and end up playing catch up.

Which of the rules stand out as possibly creating the biggest pain point for advisers?

Marlyn: Detailed disclosure under the quarterly statements rule could be particularly problematic for advisers who oversee their own reporting. Fund expenses and fees are typically single line items, but if these need to be broken down into several line items across numerous entities, that’s a lot more information that needs to be provided in a shorter time. 

These disclosures aren’t necessarily new for private entities that ultimately roll up to public entities and large managers. Previously, private fund advisers may have had more flexibility in their reporting timelines. But the new rule will likely have a bigger impact and increase operating costs for small to mid-sized advisers due to challenges around gathering accounting or joint venture partner data in a timely manner and the possible lack of an automated accounting platform.

Considering that advisers need to provide quarterly reports to strict timelines under the new rules — 90 days after the end of each fiscal year and 45 days after every other quarter end — challenges around data gathering and systems could be significant.

It sounds like data is a real issue here.

Marlyn: It is. Not only are time spent, resourcing and the possible costs associated with building a new accounting system real concerns, there’s also the real potential for error, which comes with all sorts of implications from a risk management perspective.

What about the private fund audit rule?

Marlyn: Under that new rule, advisers will have to have each fund audited separately and independently. This creates two key challenges. First, smaller advisers with smaller groups of investors may not have undertaken independent audits previously, so they will be assuming a significant new cost.

But even for those advisers whose funds are already being audited, the new rule states that audited financial statements for the first three quarters must be delivered to investors within 45 days. For the full year, statements must be delivered within 90 days, and for the fund’s fiscal year-end, they must be delivered within 120 days. It’s not unusual for firms to operate in a 90- to 150-day audit window, and those who normally take longer will have to schedule earlier audits as a priority with their accounting firms, which may come at a cost. 

What are the implications with regard to jurisdictions? Will non-US managers be affected? 

Tanya: The extraterritorial application of the new rules was an area that many advisers were watching carefully, and thankfully they have been codified by the SEC. A word I’ve seen used around this has been ‘pollination,’ so while it doesn’t necessarily have extraterritorial effects, it does pollinate into other territories.

Essentially, if an offshore adviser has a US-domiciled fund — even if it has no US investors — the new rules do apply. Where this becomes interesting, and more complex, is when offshore advisers manage both US-domiciled funds and offshore funds in the same fund structure. In this situation, the advisor needs to consider how applying the rules to their US funds might impact their offshore ones, even though the new rules don’t apply to the offshore funds.

I think the main message is that if you've got a US-domiciled fund but are an offshore adviser, it makes sense to check your position from a holistic perspective.

The new rules take effect in a staggered manner between 12 and 18 months after the final rule is published in the federal register, depending on the specific rule and an adviser’s AUM. What should firms consider now when thinking about compliance?

Tanya: As with any new regulation, there’s a risk that some firms might wait until industry bodies such as NCREIF [National Council of Real Estate Investment Fiduciaries] and PREA [Pension Real Estate Association] make statements about how the industry might be impacted. Likewise, some might wait to see what competitors do, what actions other firms take. But this always creates the risk that they might be left scrambling as the deadline approaches.

It’s important to remember that the now-codified, written annual review rule — which requires all SEC-registered advisers to document their annual compliance program reviews in writing — has to be met 60 days after federal register publication. So, firms don't have the luxury of too much time, as they must be able to demonstrate to the regulator that they've started to implement the rules within that 60-day period. 

Advisers also need to know whether they can apply for legacy status, or grandfathering provisions. There are very limited grandfathering provisions available and they depend on various factors. Therefore, it would be sensible for a manager to know promptly if they can actually make use of those. 

Marlyn: It’s also important to consider how new funds might be affected. Take, for example, advisers who are looking to raise their next funds. How might the preferential treatment rule impact their fund documents, for instance? Will they need to be rewritten?

So, what actions should advisers be taking?

Marlyn: First and foremost, an adviser should carry out an impact assessment to measure exactly how they will be affected by the new rules. Those already working with third-party providers will likely be less affected because a lot of the work will lie with those partners. 

Those who are administering their own funds and fall under the rules will be impacted to a much greater degree. Once the assessment has been done, decisions need to be made on whether additional resources will be required to meet the requirements, how data is going to be gathered, and whether new technology needs to be introduced to manage processes effectively. 

Considering that it could take months or even years, hundreds of thousands of dollars, and countless work hours to implement systems independently, meeting the 12- to 18-month window may not be feasible. So, decisions may well need to be made on whether to resource this in-house or externally.

Tanya: The reality is that once the final rule is published, the clock starts ticking. Even though private fund industry organisations filed a petition in federal court at the beginning of September requesting a judicial review of the new rules, that won’t create any pause or delay. The rules will need to be complied with, so it makes clear sense to start moving now.