The SEC not only adopted new rules designed to protect private fund investors this week, but has doubled down and also created a new reporting requirement for all registered investment advisers .

The suite of new regulations includes the adoption of six new rules under the Advisers Act – 206(4)-10; 211(h)(1)-1; 211(h)(1)-2; 211(h)(2)-1; 211(h)(2)-2; and 211(h)(2)-3 – and amendments to Rules 204-2 and 206(4)-7 for related books and records and compliance program requirements.

The bulk of the changes seek to enhance private fund investor protections by enhancing disclosure regarding compensation, sales practices, and conflicts of interest; restricting practices that can lead to investor harm; and placing additional limits on practices that are identified as contrary to the public interest and the protection of investors.

But perhaps the most significant change is the amendment of Rule 206(4)-7, addressed below.

 

Transparency: Quarterly Statements and Annual Audits

To enhance transparency, three of the rules will require registered advisers to private funds to, among other things, provide investors with:

• quarterly statements that include information regarding fund fees, expenses, and performance; and
• annual audited financial statements of the fund.

 

Additional requirements may apply to specific scenarios, such as requiring a fairness or valuation opinion in the instance of an adviser-led secondary transaction.

 

Prohibited, or Otherwise Restricted, Practices

All private fund advisers, whether or not registered with the SEC, will be prohibited from providing investors with preferential treatment regarding 1) redemptions and 2) access to information (portfolio holdings or exposures) where that preferential treatment would have a material, negative effect on investors not privy to the preferential terms. Other terms for preferential treatment rely on a disclosure-based exception which, in some cases, can require firms to provide advance notice and/or specified disclosures to all current and prospective investors.

In addition, the rules restrict other activities that the SEC finds contrary to the public interest and the protection of investors. These include –

• reducing the amount of any adviser clawback by adviser taxes;
• borrowing fund assets or receiving a loan from a private fund client; and
• charging certain fees and expenses to a private fund, such as regulatory and compliance expenses, or non pro-rata allocation of fees of the adviser or its related persons related to a portfolio investment where multiple clients have invested.

 

While not outright prohibitions, these activities may require specific disclosures and/or that the adviser obtain required consents. The final rules, however, will not permit an adviser to charge a private fund certain costs where there is a sanction for a violation of the Advisers Act or its rules.

The rules include grandfather clauses applicable to certain of the provisions which apply to 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.

 

Attention All Registered Investment Advisers (RIAs)

There is a fair bit of information for compliance folks to digest here. The devil is in the details, as policies and procedures should be updated to meet the new requirements. So even if you, or the fund’s admin, have been providing quarterly statements for years, examiners will expect them to meet the specific requirement and to find the corresponding procedures in the manual.

On that note, the amendment to Rule 206(4)-7 requires all SEC-registered advisers to document the annual review of their compliance policies and procedures: “Review and document in writing, no less frequently than annually, the adequacy of the policies and procedures established pursuant to this section and the effectiveness of their implementation”.

Most registered investment advisers have been doing this given the SEC has indirectly required this and enforced it through speeches and deficiency letters. However, given that this is new as a requirement  – layered within a suite of new regulation applicable to only a subset of RIAs –  we expect that there is risk that some advisers may miss this detail if they believe this only affects private fund managers.

SEC³ can assist investment advisers with the implementation of the new enhancements to the regulation of private fund advisers. SEC³ works with clients to customize firm’s policies and procedures. Additionally, SEC³ conducts Annual 206(4)-7 Reviews and prepare reports on behalf of its clients.

For more information, please contact us at info@sec3ccompliance.com, at (212) 706-4029 x 229, through LinkedIn or visit us on our website at www.sec3compliance.com.