A Small Entity Compliance Guide[1]

This compliance guide is divided into the following parts:

• Introduction
• Who is subject to the new private fund adviser rules and amendments?
• What information must be included in a private fund quarterly statement?
• Who must distribute quarterly statements to investors and when must they be distributed?
• What is required by the new private fund mandatory audit rule?
• What is required by the new adviser-led secondary transaction rule?
• What types of activities are restricted under the new rules?
• What requirements apply to preferential treatment (e.g., side letters) under the new rules?
• What are the recordkeeping requirements associated with the new rules?
• What amendments did the Commission make to the Advisers Act compliance rule?
• When must an adviser begin to comply with the new rules and amendments?
• Other resources
• Contacting the Commission

Introduction

On August 23, 2023, the Securities and Exchange Commission (the “Commission”) adopted new rules and rule amendments under the Investment Advisers Act of 1940 (the “Advisers Act” or the “Act”) to enhance the regulation of private fund advisers and to update the existing Advisers Act compliance rule (rule 206(4)-7), which applies to all registered investment advisers.

The new rules require private fund advisers registered with the Commission to:

• Prepare private fund quarterly statements that include detailed information regarding fund-level performance, adviser compensation, and fees and expenses, and distribute these quarterly statements to investors;
• Obtain an annual audit for each private fund; and
• Obtain a fairness opinion or valuation opinion in connection with an adviser-led secondary transaction.

The new rules prohibit all private fund advisers, regardless of registration status, from:

• Engaging in certain activities (as discussed in more detail below) with respect to a private fund that it advises or any of the fund’s investors, unless the adviser provides certain disclosures to investors and, for some activities, receives investor consent; and
• Providing (i) certain preferential treatment to investors in a private fund or a similar pool of assets that the adviser reasonably expects would have a material, negative effect on other investors and (ii) any other preferential treatment, unless disclosed to other investors in the same fund.

Additionally, the new amendments require all advisers registered with the Commission, including those that do not advise private funds, to document in writing the annual review of their compliance policies and procedures, as well as to retain certain books and records related to the new rules, as applicable.

Who is subject to the new private fund adviser rules and amendments?

The quarterly statement, audit and adviser-led secondaries rules apply to all SEC-registered investment advisers, and the restricted activities and preferential treatment rules apply to all advisers to private funds, regardless of whether they are registered with the Commission or have status as an exempt reporting adviser. The quarterly statement, audit, adviser-led secondaries, restricted activities and preferential treatment rules do not apply to investment advisers with respect to any securitized asset funds that they advise. A “securitized asset fund” is defined as any private fund whose primary purpose is to issue asset-backed securities and whose investors are primarily debt holders.

The new rules do not apply with respect to the non-U.S. private fund clients of a non-U.S. investment adviser, regardless of the non-U.S. investment adviser’s registration status and whether the non-U.S. private funds have U.S. investors.

Related amendments to the Advisers Act books and records rule, as well as amendments to the compliance rule, apply to all SEC-registered investment advisers, including those that do not advise private funds.

What information must be included in a private fund quarterly statement?

The quarterly statement rule requires an SEC-registered investment adviser to prepare and distribute quarterly statements that include a detailed accounting of the private fund’s fees and expenses and any compensation paid or allocated to the adviser or its related persons by the fund. This information must be presented in total dollar amounts in the format of a table with separate line items for each category of fee, expense, or compensation. The quarterly statement must also include a detailed accounting of any compensation allocated or paid to the investment adviser or its related persons by the fund’s underlying portfolio investments, with this information presented in a separate table with separate line items for each category of compensation. For each table, advisers are not permitted to exclude de minimis amounts, generally group smaller amounts together into broad categories or label amounts as miscellaneous.

Advisers are required to disclose adviser compensation and fund fees and expenses in each table both before and after the application of any offsets, rebates, or waivers. In addition, with respect to disclosure of adviser compensation from the fund and fund fees and expenses, the rule requires advisers to disclose the amount of any offsets or rebates carried forward during the reporting period to subsequent periods to reduce future payments or allocations to the adviser or its related persons.

The quarterly statement rule requires each statement to include prominent disclosure regarding the manner in which expenses, payments, allocations, rebates, waivers, and offsets are calculated. This disclosure will generally require advisers to describe, among other things, the structure of, and the method used to determine, any performance-based compensation set forth in the quarterly statement (such as the distribution waterfall, if applicable) and the criteria on which each type of compensation is based (e.g., whether such compensation is fixed, based on performance over a certain period, or based on the value of the fund’s assets). To facilitate an investor’s ability to seek additional information and understand the basis of any expense, payment, allocation, rebate, waiver, or offset calculation, the quarterly statement also must include cross-references to the relevant sections of the private fund’s organizational and offering documents that set forth the applicable calculation methodology.

In addition to providing information regarding fund-level adviser compensation and fees and expenses, the rule requires advisers to include standardized fund performance information in each quarterly statement provided to fund investors. The rule requires advisers to show performance of liquid funds based on net total return on an annual basis for the 10 fiscal years prior to the quarterly statement or since the fund’s inception (whichever is shorter), average annual net total returns over one-, five- and 10-fiscal year periods, and on a cumulative basis for the current fiscal year as of the end of the most recent fiscal quarter. For illiquid funds, the rule requires advisers to show performance based on internal rates of return and multiples of invested capital since inception and to present a statement of contributions and distributions. Under the quarterly statement rule, the distinguishing feature between a liquid fund and illiquid fund is that an illiquid fund is any private fund that is not required to redeem interests upon an investor’s request and has limited opportunities, if any, for investors to withdraw before termination of the fund. The rule requires advisers to display the different categories of required performance information with equal prominence.

Advisers under the rule will remain able to provide, and investors are free to request and negotiate for, disclosure of additional information to supplement the standardized baseline level (i.e., the mandatory floor) of fund-level fee and expense, adviser compensation and performance disclosure required in the quarterly statements, provided that such additional information complies with the other requirements of the new rules, the marketing rule,² and other disclosure requirements, each to the extent applicable.

The rule requires advisers to consolidate reporting for similar pools of assets to the extent doing so provides more meaningful information to the private fund’s investors and is not misleading.

Who must distribute quarterly statements to investors and when must they be distributed?

The quarterly statement rule requires an SEC-registered investment adviser to prepare a quarterly statement for any private fund that it advises and distribute the quarterly statement to the private fund’s investors, unless a quarterly statement that complies with the rule is prepared and distributed by another person. If the private fund is not a fund of funds, then a quarterly statement must be distributed within 45 days after the end of each of the first three fiscal quarters of each fiscal year and 90 days after the end of each fiscal year. If the private fund is a fund of funds, then a quarterly statement must be distributed within 75 days after the first, second and third fiscal quarter ends and 120 days after the end of the fiscal year of the private fund. For a newly formed private fund, the rule requires a quarterly statement to be prepared and distributed beginning after the fund’s second full quarter of generating operating results.

If a quarterly statement is distributed electronically through a data room, this distribution, like other electronic deliveries, should be done in accordance with the Commission’s guidance regarding electronic delivery.³

What is required by the new private fund mandatory audit rule?

The audit rule requires an SEC-registered investment adviser providing investment advice, directly or indirectly, to a private fund, to cause that fund to undergo a financial statement audit that meets the requirements set forth in paragraphs (b)(4)(i) through (b)(4)(iii) of the custody rule applicable to pooled investment vehicles subject to annual audit and to cause audited financial statements to be delivered in accordance with paragraph (c) of that rule, if the private fund does not otherwise undergo such an audit.⁴ As a result, each of the following is required under the final rule:

1. The audit must be performed by an independent public accountant that meets the standards of independence in 17 CFR 210.2-01 (rule 2-01(b) and (c) of Regulation S-X) that is registered with, and subject to regular inspection as of the commencement of the professional engagement period, and as of each calendar year-end, by the Public Company Accounting Oversight Board in accordance with its rules;
2. The audit must meet the definition of audit in 17 CFR 210.1-02(d) (rule 1-02(d) of Regulation S-X);
3. Audited financial statements must be prepared in accordance with generally accepted accounting principles; and
4. Annually within 120 days of the private fund’s fiscal year-end and promptly upon liquidation, the private fund’s audited financial statements are delivered to investors in the private fund.

For a fund that the adviser does not control and that is neither controlled by nor under common control with the adviser (e.g., an adviser to a fund of funds may select an unaffiliated sub-adviser to implement a portion of the underlying investment strategy), the adviser only needs to take all reasonable steps to cause the fund to undergo an audit that meets these elements. What constitutes “all reasonable steps” depends on the facts and circumstances. Advisers are in the best position to evaluate their control relationships over private fund clients and should be in a position to determine the appropriate steps to satisfy this standard based on their relationship with the private fund and the relevant control person.

What is required by the new adviser-led secondary transaction rule?

The adviser-led secondaries rule requires SEC-registered advisers to satisfy certain requirements if they initiate a transaction that offers private fund investors the option between selling all or a portion of their interests in the private fund and converting or exchanging them for new interests in another vehicle advised by the adviser or any of its related persons (an “adviser-led secondary transaction”). First, the adviser must obtain a fairness opinion or a valuation opinion from an independent opinion provider and distribute the opinion to private fund investors prior to the due date of the election form. Second, the adviser must prepare and distribute to investors a written summary of any material business relationships between the adviser or its related persons and the independent opinion provider within the two-year period immediately prior to the issuance date of the fairness opinion or valuation opinion.

What types of activities are restricted under the new rules?

The restricted activities rule restricts all private fund advisers, regardless of whether they are registered with the Commission, from engaging in the following activities:

• Charging or allocating to the private fund fees or expenses associated with an investigation of the adviser or its related persons by any governmental or regulatory authority without consent from fund investors. Further, an adviser may not charge the private fund fees or expenses related to an investigation that results or has resulted in a court or governmental authority imposing a sanction for a violation of the Advisers Act or the rules promulgated thereunder;
• Charging or allocating to the private fund regulatory, examination, or compliance fees or expenses of the adviser or its related persons, 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 (or potential portfolio investment) on a non-pro rata basis, unless the allocation approach is fair and equitable and the adviser distributes to investors 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 a loan or an extension of credit from a private fund client without disclosure to and consent from fund investors.

The restricted activities rule generally provides either a disclosure-based exception or a disclosure- and consent-based exception for each restricted activity. The non-pro rata restriction is subject to a before-the-fact disclosure-based exception (in addition to the requirement that the allocation be fair and reasonable), while the certain fees and expenses restrictions and the post-tax clawback restriction are subject to after-the-fact disclosure-based exceptions. The borrowing restriction and the investigation restriction are subject to a consent-based exception, which will require an adviser to seek advance consent for the restricted activity from all of the fund’s investors and obtain consent from at least a majority in interest of investors that are not related persons of the adviser.

In addition, the disclosure-based exceptions to the restrictions on certain regulatory, compliance and examination fees and expenses and post-tax clawbacks require advisers to distribute written notices to investors within 45 days after the end of the fiscal quarter in which the relevant activity occurs.

What requirements apply to preferential treatment (e.g., side letters) under the new rules?

The preferential treatment rule prohibits all private fund advisers, regardless of whether they are registered with the Commission, from providing preferential treatment to an investor with respect to redemption rights and portfolio holdings or exposure information, in each instance, that the adviser reasonably expects would have a material, negative effect on other investors. The rule includes certain exceptions from the redemptions prohibition (i.e., if the redemption right is required by law or offered to all existing and future investors) and information prohibition (i.e., if the information is offered to all other existing investors).

The preferential treatment rule requires advance written notice to prospective investors of any preferential treatment related to material economic terms, as well as post-investment written notice to current investors of all preferential treatment that the adviser or its related persons has provided to other investors in the same private fund, for an illiquid fund, as soon as reasonably practicable following the end of the fund’s fundraising period and, for a liquid fund, as soon as reasonably practicable following the investor’s investment in the private fund.

Advisers must also distribute an annual written notice to current investors in a private fund that provides specific information about any preferential treatment the adviser or its related persons has provided to other investors in the same private fund since the last written notice.

The preferential treatment rule applies to preferential treatment provided through various means, including written side letters. The rule also applies if the preferential treatment is provided indirectly, such as by an adviser’s related persons.

What are the recordkeeping requirements associated with the new rules?

The amendments to rule 204-2 require SEC-registered advisers to retain books and records related to the quarterly statement rule, the audit rule, the adviser-led secondaries rule, the restricted activities rules and the preferential treatment rule to facilitate compliance with these new rules and assist the Commission’s examination staff.

What amendments did the Commission make to the Advisers Act compliance rule?

The amendments to rule 206(4)-7 require that all advisers registered with the Commission, including those that do not advise private funds, document in writing the annual review of their compliance policies and procedures.

When must an adviser begin to comply with the new rules and amendments?

For the quarterly statement rule and audit rule, the compliance date is March 14, 2025. For the adviser-led secondaries rule, the preferential treatment rule and the restricted activities rule, the compliance dates are: for advisers with $1.5 billion or more in private funds assets under management, September 14, 2024; and for advisers with less than $1.5 billion in private funds assets under management, March 14, 2025. Compliance with the amended Advisers Act compliance rule is required by November 13, 2023.

Other resources

The adopting release can be found on the Commission’s website at https://www.sec.gov/files/rules/final/2023/ia-6383.pdf.

The proposing release can be found on the Commission’s website at https://www.sec.gov/files/rules/proposed/2022/ia-5955.pdf.

Contacting the Commission

The Commission’s Division of Investment Management is happy to assist small entities with questions regarding the new private fund adviser rules and amendments. You may submit a question by email to IMOCC@sec.gov. Additionally, you may contact the Division of Investment Management’s Office of Chief Counsel at (202) 551-6825.