Are you prepared to comply with the private fund adviser and annual compliance program review rules? 

New and enhanced SEC rules address six focus areas for private fund managers

As private fund advisers start to grapple with the SEC’s new and enhanced compliance rules, they need to understand the various requirements and compliance deadlines within those rules, and how their funds may be affected.

These rules, adopted by the SEC on August 23, 2023, address six topic areas and prescribe new obligations and requirements, primarily to private fund managers. According to the SEC, these rules aim to help increase transparency and perceived fairness to private fund investors. However, private fund managers may be wary of the potential compliance burden presented by the new requirements.

For some of these rules, the compliance deadline depends on the size of the fund, as measured by assets under management (AUM). Additionally, some rules only apply to SEC-registered advisers to private funds while others apply to all advisers of private funds.

The following is an overview of the new requirements of the enhanced private fund adviser rules and what they mean for those in the industry.

1. Quarterly Statements Rule

(Compliance Date: March 14, 2025)

The Quarterly Statements Rule requires SEC-registered private fund managers (or another person, such as the fund’s administrator) to prepare and distribute quarterly statements to investors, within a defined period after each quarter-end. These statements must contain very specific information pertaining to fund-level compensation paid to the manager, fund-level fees and expenses, carry-forward fees offsets, portfolio investment-level compensation paid to the manager and various performance metrics (metrics differ based on whether the fund is liquid or illiquid).

The SEC noted all fees and expenses are to be presented in table format and line items must be specific enough for the investor to understand what the fee/expense relates to. The SEC was very clear in its adopting release of the rule that catch-all categories such as “miscellaneous” and “other” will not be permitted, no matter how small or potentially immaterial the expenses making up those categories may be. Additionally, the SEC will require prominent disclosure that, among other things, includes cross-references to the applicable sections of the fund documents describing these fees and expenses.

You may think your fund administrator will take care of this obligation for you, and that may be the case. However, in the SEC’s eyes, ultimate responsibility for this reporting will fall on the adviser to the private fund. This means it’s imperative you discuss these obligations/requirements with your fund administrator and review the quarterly statements to confirm they comply with all prescriptions in the rule.

Additionally, there may be information needed for these statements that administrators will not be privy to, such as the amount of compensation an adviser received directly from the fund’s underlying portfolio companies during the period. For these reasons, SEC-registered fund managers must be familiar with the rule and its requirements and work with their fund administrators or internal reporting team on compliance.

For private fund managers who don’t currently have a fund administrator, now’s a good time to consider working with an administrator. Alternatively, you need to determine whether your internal reporting capabilities can handle the obligations created by this rule, and if so, begin to understand the rule and all details contained within it.

2. Preferential Treatment Rule 

(Compliance Date: September 14, 2024, for AUM over $1.5 billion and March 14, 2025, for AUM under $1.5 billion)

The Preferential Treatment Rule will primarily affect side letters that many private fund managers negotiate with certain investors. The rule will require all private fund managers, regardless of registration status, to abide by certain prohibitions (with limited exceptions) related to the granting of preferential redemption or information rights to any investor in a fund, or similar pool of assets, if the adviser reasonably expects it to have a material negative effect on other investors.

The SEC did not define “material negative effect,” but based on past rules, one can infer that most instances of preferential redemption rights or information rights where an investor can act on the information to redeem before other investors could be considered a “material negative effect” by the SEC. If you’re worried this means you may have to re-paper fund documents and agreements with limited partners, don’t be! The SEC granted grandfathered status as it pertains to the preferential redemption and information rights prohibitions, as long as your fund agreements were executed and the fund has commenced operations prior to the compliance date of the rule.

Some in the investment advisory industry may be wondering if there are any workarounds to continue offering different liquidity preferences to investors — the answer is yes. For example, an adviser may offer investors different share classes with varying fee/liquidity tradeoffs. If these share classes are offered to all investors, and the share classes are not dependent on qualifications (e.g., commitment size, commitments to future funds, etc.), this treatment should not violate the rule, depending on facts and circumstances. Consult with a qualified compliance professional regarding your situation.

The rule also requires specific disclosures and timing of delivery for these disclosures when other forms of preferential treatment are granted, such as lower fee rates, co-investment rights, etc. Advisers will need to inventory their side letter arrangements and all forms of preferential treatment granted within them to confirm they make sufficient disclosure within the prescribed time periods (depending on the type of preferential treatment) required by the rule.

3. Restricted Activities Rule

(Compliance Date: September 14, 2024, for AUM over $1.5 billion and March 14, 2025, for AUM under $1.5 billion)

The Restricted Activities Rule may be less onerous than the previous rules discussed above, but it will require disclosures, by all private fund managers regardless of registration status, to fund investors for certain activities. Those activities include charging the fund for compliance expenses of the adviser, reducing carried interest clawback by taxes applicable to the adviser and charging portfolio investment-related fees/expenses on a non pro rata basis (non pro rata treatment requires disclosure prior to the charge/allocation).

Keep in mind that compliance expenses specifically attributable to the fund, such as Form D and Form PF-related expenses, are not considered to be compliance expenses of the adviser and will not need to be disclosed separately in conjunction with this rule.

Certain other activities may require the adviser to provide disclosure and obtain consent from a majority of the unaffiliated investors in the fund. These activities include charging the fund for investigation-related expenses by a government or regulator and any arrangement where the adviser borrows from the fund. There’s a bit of relief here granted by the SEC, as it allowed for grandfathered status for the activities that require investor consent. This means if the fund agreements permit these activities and the fund commenced operations prior to the compliance date of the rule, the fund may be permitted to engage in these activities without needing to comply with the rule.

Additionally, the rule prohibits an adviser from charging its fund for investigation expenses if the investigation results in sanctions for violations of the Advisers Act. To the extent these expenses have been charged prior to the adviser knowing the result of the investigation, the SEC expects the adviser to reimburse the fund for all expenses related to the investigation resulting in the sanction.

4. Adviser-Led Secondaries Rule

(Compliance Date: September 14, 2024, for AUM over $1.5 billion and March 14, 2025, for AUM under $1.5 billion)

The Adviser-Led Secondaries Rule requires SEC-registered private fund managers who lead a secondary transaction in the fund to obtain a fairness or valuation opinion from an independent third party.

What constitutes an adviser-led secondary transaction? According to the SEC and the rule, it is any transaction initiated by the adviser that offers the private fund’s investors the choice between: (a) selling all or a portion of their interests in the private fund and (b) converting or exchanging all or a portion of their interests in the private fund for interests in another vehicle advised by the adviser. Practically speaking, if an investor has an option to remain in the fund, status quo, the transaction will likely not be subject to this rule.

Due to the required cost to obtain a fairness or valuation opinion under the rule, it may affect an adviser’s decision to engage in smaller adviser-led secondary transactions that may not warrant the associated costs.

5. Private Fund Audit Rule

(Compliance Date: September 14, 2024, for AUM over $1.5 billion and March 14, 2025, for AUM under $1.5 billion)

The Private Fund Audit Rule requires SEC-registered private fund managers to obtain an annual financial statement audit of the private funds they advise, with the same requirements as the Custody Rule’s financial statement audit. For many SEC-registered advisers, this rule will have no impact, as most already receive these audits annually to comply with the Custody Rule and therefore will most likely already be in compliance with this rule.

However, if you are an SEC-registered adviser and any private fund you manage is relying on a surprise examination to comply with the Custody Rule or is not receiving a financial statement audit for any other reason, you may want to begin exploring service providers to conduct an audit so that your fund complies with this rule.

6. Written Annual Compliance Program Review Rule

(Compliance Date: November 13, 2023)

The Written Annual Compliance Program Review Rule essentially codifies something that most SEC-registered advisers are already doing: documenting their annual compliance program reviews in writing. If you are not currently documenting this review, it’s time to start thinking about how you will do so, whether internally or with the assistance of an external service provider, such as a compliance consultant.

It was widely expected by the investments industry that this rule will now give the SEC more leverage to not only confirm SEC-registered advisers are performing an annual compliance program review, but also to examine these reviews and comment on their sufficiency and compliance with Rule 206(4)-7(b) under the Advisers Act. One thing to note, this rule will apply to all SEC-registered advisers, whether the adviser is a private fund adviser or manages strictly non-private fund clients.

Of course, as with most new rules adopted by the SEC, you should expect the SEC will require customized policies and procedures that correlate to how the adviser will comply with these new and enhanced rules.

Kaufman Rossin’s Risk Advisory Services team has a turn-key solution that can help advisers comply with the rules described above. Contact me or another Risk Advisory Services practice member for assistance with these and other SEC and FINRA regulatory compliance matters. Additionally, reach out to the Kaufman Rossin Alternative Investment Services team for assistance with matters pertaining to fund administration.