The Commission said it has adopted these “carefully tailored rules to address certain practices that may impose significant risks and harms on investors and private funds,” and that these reforms are “designed to protect those who directly or indirectly invest in private funds by increasing visibility into certain practices, establishing requirements to address practices that have the potential to lead to investor harm, and prohibiting or restricting adviser activity that is contrary to the public interest and the protection of investors.”
According to an SEC Fact Sheet, the new rules require private fund advisers who are registered with the Commission to comply with the following:
Quarterly statement rule: Provide investors with quarterly statements detailing information regarding private fund performance, fees, and expenses, designed to increase transparency;
Private fund audit rule: Obtain and distribute to investors an annual audit of each private fund it advises. This requirement must meet the audit provision of Rule 206(4)-2 of the Investment Advisers Act of 1940 (the custody rule). “These audits will provide an important check on the adviser’s valuation of private fund assets and protect private fund investors against the misappropriation of fund assets,” according to the SEC Fact Sheet.
Adviser-led secondaries rule: Registered private fund adviser must obtain 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,” according to the SEC Fact Sheet.
Advisers must also “prepare and distribute to the private fund’s investors a summary of any material business relationships the adviser has, or has had within the prior two years, with the independent opinion provider,” the Fact Sheet states. “This requirement will provide a check against an adviser’s conflicts of interest in structuring and leading such transactions.”
Requirements for all Private Fund Advisers
To address certain conflicts of interest that have the potential to lead to investor harm, the SEC has added a new rule restricting all private fund advisers from engaging in the following activities that are “contrary to the public interest and the protection of investors”:
- Charging or allocating to the private fund fees or expenses associated with an investigation of the adviser without disclosure and consent from fund investors;
- Charging or allocating to the private fund regulatory, examination, or compliance fees or expenses of the adviser, unless such fees and expenses are disclosed to investors;
- Reducing the amount of an adviser clawback by the amount of certain taxes, unless the adviser discloses the pre-tax and post-tax amount of the clawback to investors;
- Charging or allocating fees or expenses related to a portfolio investment on a non-pro rata basis, unless the allocation approach is fair and equitable and 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; and
- Borrowing or receiving an extension of credit from a private fund client without disclosure to, and consent from, fund investors.
Preferential treatment rule: The final rules prohibit private fund advisers from providing preferential treatment to investors regarding “certain redemptions from the fund, unless the ability to redeem is required by applicable law or the adviser offers the preferential redemption rights to all other investors without qualification; and certain preferential information about portfolio holdings or exposures, unless such preferential information is offered to all investors.
Preferential treatment is also prohibited, “unless certain terms are disclosed in advance of an investor’s investment in the private fund and all terms are disclosed after the investor’s investment,” according to the Fact Sheet. The preferential treatment rule is intended to “address material, negative effects of specific types of preferential treatment on other investors,” the SEC said.
Legacy Status: The SEC is also providing legacy status “for the prohibitions-aspect of the Preferential Treatment Rule and the aspects of the Restricted Activities Rule that require investor consent,” the SEC Fact Sheet states. “Such legacy status will apply to those governing agreements entered into in writing prior to the compliance date and with respect to funds that have commenced operations as of the compliance date.”
“Private funds and their advisers play an important role in nearly every sector of the capital markets,” said SEC Chair Gary Gensler. “By enhancing advisers’ transparency and integrity, we will help promote greater competition and thereby efficiency. Consistent with our mission and Congressional mandate, we advance today’s rules on behalf of all investors — big or small, institutional or retail, sophisticated or not.” 
Jaclyn Jaeger is a contributing editor at Compliance Chief 360° and a freelance business writer based in Manchester, New Hampshire.