New SEC private fund adviser rules

How should private equity groups prepare?

June 2024 update: SEC private fund advisers rules overturned

On June 5, 2024, a panel of the U.S. Court of Appeals for the 5th Circuit ruled to vacate the Securities and Exchange Commission (SEC) Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews final rules from Aug. 23, 2023, in a 3-0 decision. Affected rules for private fund advisers include:

- Restricted activities
- Preferential treatment
- Audit requirements
- Quarterly statements
- Adviser-led secondaries

Those private fund advisers with $1.5 billion or more in private fund assets under management would have needed to comply with the restricted activities, preferential treatment, and adviser-led secondaries rules by Sept. 14, 2024, while the compliance date for all other private fund advisers would have been March 14, 2025. Finally, the compliance date for the audit requirements and quarterly statement rules would have been March 14, 2025, for all private fund advisers.

The court’s decision also affects the portions of the final rules that were amendments to existing rules (for example, compliance rule and books and records rule), including those that were already in effect. The court ruled that the final rules exceeded the SEC’s statutory authority, which means the SEC was not authorized to issue the final rules. Absent any further action, the 5th Circuit’s decision will vacate the final rules on July 29, 2024.

Additional regulatory uncertainty exists because the 5th Circuit ruling might indirectly affect other pending SEC rule proposals. For example, the Safeguarding Adviser Client Assets rule proposal, which was reopened for comment when the SEC issued the final private fund advisers rules, relies on a statutory authority similar to the SEC authority asserted in the now vacated private fund advisers rules. In addition, the ruling might affect how the Division of Examinations executes on its 2024 priorities, which include examinations of investment advisers to private funds.

We will keep you informed as developments occur.

SEC rules impose significant new requirements on all private fund advisers. Here’s a structured implementation approach to help private equity groups comply.

Private fund adviser rules adopted by the Securities and Exchange Commission (SEC) in 2023 under the Investment Advisers Act of 1940 impose significant new audit, disclosure, and reporting requirements on all private funds, including private equity funds. After determining which of the specific requirements and compliance deadlines apply to them, fund leaders will need to identify the necessary controls, policies, and procedures and then launch a structured implementation strategy for timely compliance.

Following are some challenges to compliance as well as some practical steps that private fund managing partners, advisers, and executive team members can take to begin developing an implementation approach.

Learn more about the importance of an independent, quality fund audit for investment relations.

See our solutions

The rules at a glance

The SEC’s new private fund adviser requirements are spelled out in detail in the final rule. An SEC fact sheet and implementation guidance summarize the requirements.¹

In brief, the new rules fall into three categories:

Requirements that apply to SEC-registered private fund advisers

Quarterly statements. Registered private fund advisers must provide investors with quarterly statements regarding fund performance, costs, fees, expenses, and compensation.
Annual audits. All private funds are required to undergo an annual GAAP-compliant financial statement audit that must be completed within 120 days of the fund’s fiscal year-end.
Adviser-led secondaries. Registered private fund advisers must obtain a fairness or valuation opinion when they offer existing investors the option of either selling their interests or exchanging them into another fund advised by the adviser or a related party.
Books and records. The act updates existing books and records rules to include new requirements.

Requirements that apply to all private fund advisers, including nonregistrants

Restricted activities. The new rules prohibit all fund advisers from charging the fund for certain regulatory or compliance expenses without investor consent. It also prohibits certain other adviser activities related to fee allocations, clawbacks for tax purposes, and loans from the fund or clients.
Preferential treatment. Advisers cannot give investors preferential information, redemption rights, or other preferential treatment that could have a material negative effect on other investors.

Requirement that applies to all SEC-registered advisers

Compliance documentation. All SEC-registered advisers, including those that do not advise private funds, are now required to document in writing the required annual review of their compliance policies and procedures.

The compliance deadlines for the new rules vary. Some of the review and documentation requirements are already in effect. Other reporting, audit, and operational requirements must be met by late 2024 or early 2025, depending on the size of the fund.

In addition, certain rules may be grandfathered in for some previously established funds. For example, the prohibition against an adviser borrowing from a fund does not apply if such loans were part of the fund’s partnership or subscription agreements. The same exemption applies to certain preferential redemption rights that were included in the original fund documentation.

Nevertheless, even if their funds are exempt from certain requirements, fund managers could find another incentive for compliance, as potential investors start factoring compliance with the new disclosure, audit, and operational requirements into their investment decisions.

Likely challenges for private equity group managers and advisers

As fund managers, advisers, and their management teams begin working toward compliance, several common problems and recurring areas of concern are emerging. These include:

Reporting inconsistencies. In some instances, fund managers and their third-party administrators measure the fund’s internal rate of return (IRR) and other performance metrics in different ways. Under the new rules, it is essential that all concerned use the same source data and formulas and that they communicate fund performance consistently and accurately to investors.
Expense charges. Fund managers and administrators also should verify that any expenses charged to the fund are actually allowed by the fund’s legal documents and that the charges are reported to investors consistently. For example, if managers want to exclude certain one-time expenses from the fund’s IRR calculations, all parties should be in agreement and apply the same standards to their reports.
Inadequate disclosures. The new rules require full disclosure of related-party transactions. Fund managers should be sure any such transactions meet arm’s-length standards and that the disclosures of these transactions are true and accurate. This is particularly applicable when continuation funds acquire an existing fund’s underlying assets, an increasingly common situation in today’s markets.
Compliance failures. The new annual compliance review and related documentation requirements are only one of several new responsibilities that fund managers and their compliance teams will need to address. Fund managers must demonstrate they are actually meeting the standards and practices spelled out in their fund documents.

A structured, holistic compliance strategy

Considering the variety and complexity of some of the compliance challenges they are likely to encounter, prudent fund managers will want to take a structured, holistic approach to the new rules, engaging with a broad range of individuals and organizations to manage their compliance efforts. As a starting point, here are some critical first steps:

Begin by consulting with the fund’s legal counsel to verify which of the new requirements are specifically applicable to the fund and to identify any obvious gaps or shortcomings in current policies and procedures.
Review existing fund documents to identify any provisions that do not comply with the new rules. For any inconsistencies not grandfathered in (such as certain exceptions to the restricted activities and preferential treatment rules), fund managers should take steps to make any necessary updates.
Coordinate with the fund administrator to establish consistency in how the fund’s performance, expenses, and other metrics are calculated, and verify that all expenses are charged appropriately.
Contact auditors to be sure the fund’s management team is using the same criteria and standards. Both managers and auditors should have a clear understanding of what the annual audit will entail and what will be expected from them.
Check current management and disclosure practices to be sure that the standards and requirements spelled out in the offering memorandum, limited partnership agreement, and subscription agreement are being implemented as required.
Establish procedures and internal controls for future transactions that are compliant with new restricted activity and preferential treatment requirements.
Update management teams in the fund’s portfolio companies to be sure they understand any changes that might be needed in their reporting practices or timing, and confirm they are prepared to accommodate the changes.

Although the new rules impose some significant additional requirements on fund managers and executives, a measured, structured approach can help make the compliance effort more manageable. Ideally, fund managers and advisers will be able to look beyond regulatory compliance alone and recognize that the new rules provide a potentially worthwhile opportunity to upgrade their fund management practices by providing greater transparency, improved accountability, and more open disclosure of critical data – to the benefit of all concerned.

¹ In addition, Crowe has published an extensive insights article, “SEC Private Fund Advisers Rule Boosts Investor Protection,” that explores some of the governance and operational issues private equity groups can expect to encounter.