Private capital managers saw a major change set into motion this summer – on August 23, 2023, the Securities and Exchange Commission (SEC) adopted new rules and amendments under the Investment Advisers Act of 1940 (Advisers Act) that affect private funds and their advisers. This final rule represents a significant shift in the regulatory landscape for private fund advisors.

The path to the current SEC regulations for private funds has been shaped by significant financial events and evolving market dynamics. This journey began in earnest following the financial crisis of 2008, a pivotal moment that highlighted vulnerabilities in financial markets and the need for greater regulatory oversight. Subsequent years saw a gradual but steady shift towards increased transparency and accountability within the financial sector.

These rules are designed to protect investors by improving transparency and addressing potential conflicts of interest while also prohibiting preferential treatment and restricting certain activities without disclosure or disclosure and consent. The adopting release of the new rules will require advisers to re-evaluate their existing practices and modify or enhance operational procedures and disclosures. The limitations and requirements of the new rules are expected to increase the cost and complexity of compliance for registered and non-registered advisers, including exempt reporting advisers. 

The private fund rules sets a crucial new tone for regulation in the private fund industry. After allowing it to grow largely unchecked for decades in the U.S., the SEC is now sending the signal that it feels the private capital space has ballooned to a point where it requires guardrails in order to provide a fair experience to investors. It’s a clear indication that the era of less stringent oversight for private fund advisors is evolving.

So what does this mean for the average private fund manager? Read on for our primer of the new rules, and to learn why these transitions make capable accounting and reporting software more crucial than ever. 

New rules for Registered Private Funds Advisers  

Quarterly Statement Rule

Rule:

Registered private fund advisers must distribute a quarterly statement to private fund investors that that discloses compensation and fees. This quarterly statement rule is a critical component of the new rules, ensuring transparency for every private fund investor. This includes detailed information on the following:

• Compensation, fees, and expenses paid to the adviser and by the private fund. Amounts must be presented both before and after factoring in any offsets, rebates, or waivers.
• Disclose any offsets or rebates to be carried forward to subsequent periods.
• Portfolio compensation paid to the investment adviser.
• Disclose the way expenses, payments, allocations, rebates, waivers, and offsets are calculated.
• Standardize fund performance information. Advisers must determine if a fund is liquid or illiquid. Liquid funds provide net returns for past 10 fiscal years or inception, average net total returns over 1-, 5-, and 10-year fiscal periods and cumulative net total return for the current fiscal year. Illiquid funds to provide gross and net IRR, gross and net MOIC, and gross and net IRR and MOIC for realized and unrealized investments. Illiquid funds must report fund performance with and without impact of fund-level subscriptions facilities.

Transition Period:

• 18 months following the date of publication in the Federal Register.

Reporting Timeframe:

• 45 days following Q1-Q3 and 90 days following Q4.
• For fund of funds – 90 days following Q1-Q3 and 120 days following Q4.

Impact:

• Large private fund advisers with extensive resources might find adapting to these new rules more manageable, whereas smaller advisers could face significant challenges due to limited back \-office resources. The increased administrative burden could particularly impact smaller funds in terms of both costs and operational complexity. This shift demands robust investment accounting software capable of handling nuanced financial details for investor communication.

Private Fund Audit Rule

Rule:

Private fund advisers are required to obtain an annual financial statement audit of the private funds they advise, directly or indirectly. This audit rule is a major step towards ensuring the integrity of financial statements in the private funds industry.

Transition Period:

• 18 months following the date of publication in the Federal Register.

Impact:

• Many private fund advisers are already providing audited financial statements in compliance with the custody rule. Private Advisers who opt out of this requirement in favor of a surprise examination will be affected. The intent of this rule is to protect investors from the misappropriation of fund assets, check adviser’s valuation of private fund assets, and check on certain conflicts of interest between the adviser and private fund investors.
• The private fund audit rule introduces new compliance layers, especially for funds with intricate investments. Funds must adapt their internal processes to accommodate regular audits, increasing the reliance on external audit services and internal investment compliance software systems.

 

Adviser-Led Secondaries Rule

Rule:

This rule transforms secondary market transactions. Funds regularly engaging in these need to obtain independent fairness opinions, adding administrative complexity and ensuring equitable treatment in such transactions.

• Obtain a fairness opinion or valuation opinion.
• Disclose to investors any material relationships with the independent opinion provider over the last two years.

Transition Period:

• 12 months following date of publication in Federal Register for Large Advisors with AUM >=$1.5B
• 18 months following date of publication in Federal Register for Small Advisors with AUM < $1.5B

Impact:

• Advisers are required to obtain a fairness opinion from an independent opinion provider and disclose any associated material relationship. The rule is intended to prevent a conflict of interest when structuring and leading such transactions.

READ MORE: OUR GUIDE TO PRIVATE EQUITY SECONDARIES 

Applicable to All Private Fund Advisers

Restricted Activities Rule

Rule:

This rule restricts all private fund advisers from engaging in activities that are contrary to the public interest and protection of investors. Advisers are required to either disclose or obtain consent and disclose certain activities to investors either before or after an event.

Permitted with Disclosure

• Charging or allocating to the fund regulatory, examination, or compliance fees/expenses of the adviser.
• Disclose within 45 days following the fiscal quarter end.
• Reducing the amount of adviser clawback for taxes – requires disclosure of pre-tax and post-tax amount of clawback.
• Charging or allocating fees or expenses related to a portfolio investment on a non-pro rata basis unless the approach is fair and equitable.
• Disclose prior with description of how the allocation is fair and equitable.

Permitted with Disclosure and Consent

• Charging or allocating to the fund fees or expenses associated with an investigation of the adviser.
• Borrowing or receiving an extension of credit from a private fund client.

Impact:

Restricts activities that private fund advisers can engage in which may result in a conflict of interest and potentially lead to investor harm. Requires additional disclosures and/or consent from investors. Will result in more time spent preparing required disclosures and in tracking information such as pre-tax and post-tax clawback values.

 

Preferential Treatment Rule

Rule:

Prohibits all private fund advisers from providing preferential treatment terms to investors regarding:

• Certain fund redemptions unless required by law or offered to all other investors.
• Preferential information about portfolio holdings or exposures unless offered to all investors.

Other preferential terms must be disclosed to current and prospective investors.

Transition Period:

• 12 months following date of publication in Federal Register for Large Advisors with AUM >=$1.5B
• 18 months following date of publication in Federal Register for Small Advisors with AUM < $1.5B

Impact:

Side letters and/or any other preferential agreements must be disclosed to all investors. Private agreements will no longer be applicable unless grandfathered under “Legacy Status.”

Legacy Status

Legacy status applies to governing agreements entered into prior to the Compliance Date if the applicable rule would require the parties to amend the agreements. Legacy status is provided under the prohibition’s aspect of the Preferential Treatment Rule and the aspects of the Restricted Activities Rule that require investor consent. Legacy status does not permit advisers fees or expenses related to “sanctioned matters.”

 

All Registered Advisers

Compliance Rule Amendment

Rule:

All registered advisers, including those without private client funds, must document in writing the required annual review of their compliance policies and procedures. This amendment stresses the importance of comprehensive compliance policies. It’s particularly crucial for funds that previously lacked such policies, signaling a shift towards more regulated fund operations.

Transition Period:

• Compliance with the amended Advisers Act compliance rule will be required 60 days after publication in the Federal Register.

For full details on these amendments to the Investment Advisers Act of 1940, you can review the SEC Fact Sheet and Final Rule. 

How Allvue helps in this new regulatory era 

With these new rules emerging, it becomes more important than ever for private fund managers to run integrated data operations. Mistakes and delays may have had a negative impact on the investor experience before, but now come at a higher cost if they go against regulatory agencies. 

Luckily, Allvue offers a full suite of technology that answers the top challenges that these new rules pose. With all of this important information in one system, back-office teammates can stay in the loop rather than getting blocked by siloed technology when seeking out key data. 

• Our Fund Accounting platform provides a clean and efficient true general ledger for booking all entries, no matter how complex, and housing all back-office data. This helps your team close the books and fire off crucial reporting safely within new deadlines mandated by the SEC. We at Allvue are always working to further streamline the accounting and reporting process to make it as painless as possible. 
• Our Investor Portal is a reliable and customizable home base for your investors to access all the reporting and data they’re entitled to as regulated by the SEC.  

• Our Investor and Investment Management CRM platform integrates with our accounting and portal system to help you stay in the loop on LPA agreements and conditions. Our technology makes it simple and streamlined to communicate terms and treatment for other investors in the fund, as required by the new rules. 

These new rules inarguably place new burdens on private fund managers in how they set up investor relationships and communicate fund information to them. But with the right technology on their side, managers can significantly ease the transition. 

To learn more about Allvue’s platforms, watch our software in action or download a demo below.