A Guide to the New SEC Rules Applicable to Private Fund Advisors. What are they and how do they apply to you?

EXECUTIVE SUMMARY

The SEC adopted new rules and amendments under the Investment Advisers Act on August 23, 2023, which impose substantial new regulatory obligations and place significant restraints on traditional practices used by private funds advisors. We believe these not to be incremental, but a paradigm shift by the SEC in its approach to the private markets. We have taken a comprehensive look at these rules in our Legal Roadmap Series and are sharing our in-depth review and preliminary thoughts on the implications in “A Guide to the New SEC Rules Applicable to Private Fund Advisors” posted here.

On August 23, 2023, the Securities and Exchange Commission (“SEC” or “Commission”) adopted new rules and amendments (the “Final Rules”) under the Investment Advisers Act of 1940 (the “Advisers Act”), imposing substantial new regulatory obligations and placing significant restraints on traditional practices used by investment advisers to private funds. The new rules require compliance by various deadlines set forth in the rules. SEC-registered private fund advisers will now be required to distribute Quarterly Statements to investors detailing information regarding private fund performance, fees, and expenses. Such advisers will also be required to “cause” advised private funds to undergo an annual financial statement audit that meets the requirements of the audit provision in the Advisers Act Custody Rule and to “cause” the fund to distribute the audited financials to investors. Private fund advisers will soon be required to obtain fairness or valuation opinions in connection with adviser-led secondary transactions. All advisers to private funds, whether or not registered with the Commission, are now subject to rules prohibiting certain activities and restricting preferential treatment for select investors, activities that have historically been widespread among private fund advisers. Substantial new recordkeeping requirements are imposed on fund advisers.

CONTEXT AND CURRENT EVENTS

On August 23, 2023, the Securities and Exchange Commission (“SEC” or “Commission”) adopted new rules and amendments (the “Final Rules”) under the Investment Advisers Act of 1940 (the “Advisers Act”), imposing substantial new regulatory obligations and placing significant restraints on traditional practices used by investment advisers to private funds. The Final Rules sizably increase the regulatory burden for private fund advisers and, with respect to at least one new requirement, even for investment advisers who do not advise private funds. Industry response was immediate, with a collective roar of outrage from many private sector participants.

The Commission voted along party lines, 3-2, to adopt the new rules.

On September 1, a group of industry trade associations filed a Petition for Review in the U.S. Court of Appeals for the Fifth Circuit seeking to hold the Final Rules unlawful and requesting the court to vacate the rules and set them aside. The trade associations argue that the SEC has overstepped its statutory authority and core legislative mandate, damaging the markets by increasing fees, reducing competition, and gravely limiting choices for institutional investors, including pension funds, public and private foundations, and endowments. Specifically, the associations argue, the Final Rules limit the right of private fund advisers and their investors to tailor their relationships and interactions with certain clients, enact overreaching prohibitions and restrictions on certain traditionally-accepted private fund adviser activities, and impose onerous, costly disclosure requirements and administrative obligations on private fund advisers. They argue that the Final Rules, as adopted, would hinder entrepreneurialism, flexibility, and investment returns, which “until now, made private funds an increasingly attractive option for the world’s most sophisticated investors.”

Before the Final Rules were adopted, the Commission requested comments on the proposed rules. Over 375 comment letters were submitted, and over 120 meetings were held with SEC officials. Many commentators’ objections are addressed in the Adopting Release.

The Commission, in the Adopting Release, argues that the new rules are necessary to enhance investor confidence in the private fund markets and improve efficiency, competition, and capital formation in the U.S. Based on its oversight and examinations of private funds, the Commission observed three primary factors that contribute to risks and harms to investors in private funds: lack of transparency, conflicts of interest, and lack of governance mechanisms . The Final Rules are tailored to address these issues.

WHAT PRIVATE FUND ADVISERS ARE SUBJECT TO THE NEW RULES?

 In the Adopting Release, the SEC provides that the Final Rules do not apply to investment advisers with respect to securitized asset funds. These advisers will not be required to comply with the final rules, but only with respect to the securitized asset funds they advise. The rules will apply, however, to private advisers’ advised credit funds, hedge funds, private equity funds, venture capital fuds, real estate funds and other private funds.

 The Final Rules do not apply to SEC-registered advisers who are located outside of the United States (offshore advisers), with respect to their non-U.S. private fund clients, regardless of whether they have U.S. investors.

 The Quarterly Statement Rule is only applicable to advisers that are registered, or required to be registered, with the Commission. Those advising less than $150 million private fund assets under management and those with less than $100 million in regulatory AUM, registered with, and subject to examination by, the States will not be subject to the Quarterly Statement Rule.

 Unless a federal court or the Commission itself stay the application of the Final Rules, they are in force. The compliance date deadlines are set forth in the rules (and discussed below).

THE FINAL RULES- WHAT DO THEY SAY?

The Final Rules consist of five sets of regulations and prohibitions, labelled in the Adopting Release as the Quarterly Statement Rule, the Audit Rule, and the Adviser-Led Secondary Rule, the Restricted Activities Rule; and the Preferential Treatment Rule.

1. The Quarterly Statement Rule

SEC-registered private fund advisers are now required to provide investors with Quarterly Statements detailing information regarding private fund performance, fees, and expenses. This rule applies to any private fund the Adviser advises, directly or indirectly, that has at least two full fiscal quarters of operating results. The Quarterly Statement must be distributed to the fund’s investors 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 the fiscal year; however, if the private fund is a fund of funds, the statement must be distributed within 75 days after the end of the first three fiscal quarters and within 120 days after the end of each fiscal year, unless such a quarterly statement is prepared and distributed by another person. The Quarterly Statement must contain a fund table disclosing the following information, presented both before and after the application of any offsets, rebates, or waivers for the information:

• A detailed accounting of all compensation, fees, and other amounts allocated or paid to the investment adviser or any of its related persons by the private fund during the reporting period, with separate line items for each category of allocation or payment reflecting the total dollar amount, including, but not limited to, management, advisory, sub-advisory, or similar fees or payments, and performance-based compensation.
• 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 must also contain a portfolio investment table, disclosing a detailed accounting of all portfolio investment compensation allocated or paid to the adviser or any of its related persons by the investment during the reporting period, with separate line items for each category of allocation or payment reflecting the total dollar amount, presented both before and after the application of any offsets, rebates or waivers.

The statement must include prominent disclosure of how expenses, payments, allocations, rebates, waivers, and offsets are calculated, and include cross references to the private fund’s organizational offering documents that set forth the applicable calculation methodology.

• For illiquid funds, performance measures shown since inception of the fund through the end of the quarter covered by the statement or, if such numbers are not available, through the most recent practicable date, computed with and without the impact of fund level subscription facilities:
  • Gross internal rate of return and gross multiple of invested capital for the illiquid fund
  • Net internal rate of return and net multiple of invested capital for the illiquid fund; and
  • Gross internal rate of return and gross multiple of invested capital for the realized and unrealized portions of the illiquid fund’s portfolio, with the realized and unrealized performance shown separately.
  • For illiquid funds, the statement must contain a statement of contributions and distributions for the illiquid fund and must include the date as of which the performance information is current through and include prominent disclosure of the criteria used and assumptions made in calculating the performance.
• For liquid funds, the statement must present annual net total returns for each fiscal year over the past ten fiscal years or since inception, and average annual net total returns over the one-, five-, and ten-fiscal year periods; and the cumulative net total return for the current fiscal year as of the end of the most recent fiscal quarter covered by the statement.
  Grandfathering- No grandfathering provisions are available with respect to the Quarterly Statement Rule.

2. The Mandatory Private Fund Adviser Audit Rule

SEC registered adviser firms are required to:

• Cause advised private funds to undergo an annual financial statement audit that meets the
  requirements of the audit provision in the Advisers Act Custody Rule.
• If the adviser does not control the fund, and is neither controlled by nor under common control with the fund, if the adviser does not take all reasonable steps to cause the fund to undergo an audit, and to cause audited financial statement to be delivered, and the fund does not otherwise undergo such an audit, the adviser is prohibited from providing investment advice, directly or indirectly, to the private fund.
• Prepare and retain records relating to compliance with the Audit Rule.

Grandfathering- No grandfathering provisions apply to this rule.

3. The Adviser-Led Secondaries Rule

SEC-registered advisers to a private fund conducting an adviser-led secondary transaction must, prior to the due date of the election form in respect of the adviser-led secondary transaction, prepare an distribute to investors in the fund a fairness opinion or valuation opinion, from an independent opinion provider, and must prepare and distribute to fund investors a written summary of any material business relationships between the adviser or its related persons and the independent opinion provider.

Grandfathering- No grandfathering provisions apply to this rule.

4. The Restricted Activities Rule

This rule applies to all private fund advisers, including exempt reporting advisers. All private fund advisers, regardless of whether they are registered with the SEC, are restricted from:

• Charging or allocating to an advised private fund fees or expenses related to a portfolio investment (or potential portfolio investment) on a non-pro rata basis when other private funds or clients advised by the adviser or its related persons have invested or propose to invest in the same portfolio investment, unless the non- pro rata charge or allocation is fair and equitable under the circumstances, and prior to charging or allocating such fees or expenses to the fund, the adviser distributes to each investor a written notice of the non- pro rata charge or allocation, and a description of how it is fair and equitable under the circumstances.
• Reducing the amount of an adviser clawback of actual, potential, or hypothetical taxes applicable to the adviser, its related persons, or their respective owners or interest holders, unless the adviser distributes a written notice to the investors that sets forth the aggregate dollar amount of the adviser clawback, before and after any reduction for actual, potential, or hypothetical taxes, within 45 days after the end of the fiscal quarter in which the clawback occurs.
• Borrowing money, securities, or other private fund assets, or receiving a loan or an extension of credit from a private fund client, unless the adviser distributes to each investor a written description of the material terms of, and requests each investor to consent to, such borrowing, loan, or extension of credit, and obtains written consent from at least a majority in interest of the fund’s investors that are not related persons of the adviser.
• Charging or allocating to a private fund any regulatory or compliance expenses, or fees or expenses associated with a regulatory examination of the adviser or its related persons, unless the adviser distributes a written notice to the investors of any such fees or expenses, and the dollar amount thereof, to the investors, in writing, within 45 days after the end of the fiscal quarter in which the charge occurs.
• Charging or allocating to the fund any fees or expenses associated with an investigation of the adviser or its related persons by any governmental or regulatory authority, unless the adviser has requested each investor to consent to, and obtains written consent from at least a majority in interest of the investors that are not related persons of the adviser for, such charge or allocation; with the caveat that, in the event an investigation results in a sanction for a violation of the Advisers Act or rules thereunder, charging or allocating associated expenses to the advised private fund is prohibited.

Grandfathering- The above-listed rules do not apply with respect to contractual agreements if the private fund has commenced operations as of the compliance date, and if the agreements were entered into in writing prior to the compliance date, if the rule would require the parties to amend such agreements. (However, this grandfathering exclusion does not permit an investment adviser to a private fund to charge or allocate to a fund the fees or expenses related to a regulatory investigation that results in sanctions for violations of Advisers Act.)

5. The Preferential Treatment Rules

The Preferential Treatment Rules prohibit all private fund advisers, regardless of whether they are registered with the Commission (including exempt reporting advisers), from:

• Granting an investor in a private fund or in a similar pool of assets the ability to redeem its interest on terms that the adviser reasonably expects to have a material, negative effect on other investors in that private fund or pool, unless the redemptions are required by applicable law, rule, regulation, or order of certain governmental authorities. The terms of such a redemption are permitted if the adviser has offered the same redemption ability to all existing investors and will continue to offer the same redemption ability to all future investors in the fund or pool.
  Grandfathering – This rule will not apply with respect to contractual agreements governing a private fund that has commenced operations as of the compliance date and that were entered into in writing prior to the compliance date if the rule would require the parties to amend their governing agreements.
• Providing information regarding portfolio holdings or exposures of a private fund, or of a similar pool of assets, to any investor, if the adviser reasonably expects that providing the information would have a material negative effect on other investors in that private fund or pool, unless such information is provided to all other existing investors at the same, or substantially the same, time.
  Grandfathering – This rule will not apply with respect to contractual agreements governing a private fund that has commenced operations as of the compliance date and that were entered into in writing prior to the compliance date if the rule would require the parties to amend their governing agreements.
• Advisers may not provide any preferential treatment to any investor in the private fund unless the adviser provides each prospective investor in the private fund, prior to the investor’s investment, a written notice that provides specific information regarding any preferential treatment related to any material economic terms that the adviser or its related persons provide to other investors in the same private fund. The adviser must distribute to current investors a comprehensive, annual disclosure of all preferential treatment provided by the adviser or its related persons. With respect to illiquid funds, the written notice of all preferential treatment provided to other investors in the same private fund must be distributed as soon as is reasonably practicable following the end of the fund’s fundraising period. For a liquid fund, the written notice must be provided as soon as reasonably practicable following the investor’s investment in the private fund. On an ongoing basis, the written notice must disclose such information with respect to the period since the last written notice.

Note: Advisers must disclose terms of side letter agreements, but do not have to disclose the identity of the specific investor that received a preferential term and can choose to anonymize that information.

Grandfathering- The Final Rules do not allow any grandfathering with respect to contracts affected by the above rule.

RECORDKEEPING REQUIREMENTS

The recordkeeping requirement in the Final Rules are substantial:

• All SEC-registered advisers, regardless of whether they advise private funds, are required to document in writing the required annual review of their compliance policies and procedures (the “Compliance Rule amendment”).
• Investment advisers are also required to keep a copy of any Quarterly Statement distributed, along with a record of each addressee and the corresponding date sent; and records evidencing the calculation method for all expenses, payment, allocations, rebates, offsets, waivers, and performance listed on any statement delivered.
• For each private fund client, the adviser must maintain a copy of any audited financial statements prepared and distributed under the Final Rules, along with a record of distribution; or a record documenting steps taken by the adviser to cause the private fund client to undergo an audit, if the adviser has no control relationship with the private fund client.
• Advisers must maintain records documenting and substantiating the adviser’s determination that a private fund client is liquid or illiquid.
• Advisers must maintain copies of any fairness option or valuation opinion and the “material business relationship summary” distributed, along with distribution records.

DEADLINES FOR COMPLIANCE

The deadlines for compliance, running from the publication of the Final Rules in the Federal Register, are as follows:
The compliance dates of the Final Rules vary as follows:

• The Quarterly Statement Rule and the Private Fund Audit Rule have an 18-month transition period;
• The Restricted Activities Rule, the Preferential Treatment Rule and the Adviser-Led Secondaries Rule:
  • 18-month transition period for smaller private fund advisers (those with less than $1.5 billion in private funds assets under management);
  • 12-month transition period for larger private fund advisers.
• The Recordkeeping Rule amendment
  • 18-month transition period for smaller private fund advisers;
  • 12- or 18- month transition period for larger private fund advisers, in conjunction with the underlying Final Rules; and
• The Compliance Rule amendment: 60 days.

The SEC believes that, by allowing a longer transition period for smaller advisers, the costs of compliance would be lessened through the sharing of industry knowledge from larger advisers that are required to comply at least six months earlier.

NOTEWORTHY OBSERVATIONS

1. The Final Rules do not include the proposed rule prohibiting private fund advisers from limiting their liability or seeking indemnification from their advised private funds for negligence, willful misfeasance, bad faith, or recklessness, in proving services to their clients. In the Adopting Release, the Commission reasoned that such a prohibition was unnecessary, because advisers are bound by both a Federal fiduciary duty to clients and the antifraud provisions of the Advisers Act.

First, the Commission expressly states in the Adopting Release that it is reaffirming its views on how an investment adviser’s fiduciary duty applies to its private fund clients and how the antifraud provisions apply to the adviser’s dealings with clients and fund investors.

The Commission takes the position that an adviser violates the antifraud provisions when there is a contract provision explicitly or generically waiving any or all of the adviser’s fiduciary duties or waiving the adviser’s Federal fiduciary duty, if such provision is not accompanied by a savings clause explaining that the client retains certain non-waivable rights. “A breach of the Federal fiduciary duty may involve conduct that is intentional, reckless, or negligent.” Similarly, according to the Commission, a contract term providing that an adviser may receive reimbursement, indemnification, or exculpation for breaching its Federal fiduciary duty would operate effectively as a waiver, which would be invalid under the Adviser’s Act.

With regard to waivers of conflicts of interest, the Commission explained that whether such a waiver would amount to a breach of fiduciary duty to the client fund or to investors or a violation of the antifraud provisions would require application of a facts and circumstances test. The Commission explained that whether hedge clauses and waiver clauses would violate the antifraud provisions would have to be determined based on the particular facts and circumstances. Full and fair disclosure of the conflict of interest, sufficiently clear and detailed to allow the client or investor to make an informed decision whether to consent to the conflict of interest or reject it, could be sufficient to satisfy the adviser’s duties. Whether disclosure is adequate would depend on the nature of the client (retail or institutional, for example) and the services in question. “To the extent that a hedge clause creates a conflict of interest between the adviser and its client, the adviser must address the conflict as required by its duty of loyalty.”

2. The Quarterly Statement Rule for SEC-registered private fund advisers is quite extensive and some argue may complicate private fund advisers’ compliance with the Marketing Rule.

3. A number of provisions in the Final Rules use the term “material.” The Commission does not define “material” for purposes of the rules. Not only does this creates uncertainty and, most likely, a lack of congruity among adviser practices, but an adviser could be exposed to liability under the antifraud provisions if the Commission disputes an adviser’s subjective determination regarding materiality of information.

4. The SEC did not adopt the provision in the proposed rule prohibiting a private fund adviser from
charging fees in connection with any services that the investment adviser does not, or does not reasonably expect to, provide to the portfolio investment. Nevertheless, the Commission view is that imposition of such fees is likely inconsistent with Federal fiduciary duties of loyalty and good faith.

RECOMMENDED ACTION STEPS FOR CLIENT ADVISERS TO PRIVATE FUNDS:

1. Prior to the deadlines for compliance, private fund advisers should review their existing fund documents and/or contractual agreements to determine whether they qualify for grandfathering. If their documents and agreements do not qualify, they should review them for compliance with the new Final Rules, especially with regard to the requirements and prohibitions of the Preferential Treatment, Restricted Activity, and Adviser-led Secondaries rules.

2. Advisers should also review contract clauses limiting the adviser’s liability or requiring indemnification, reimbursement, or exculpation, to ensure they do not amount to a waiver of the adviser’s fiduciary duties to clients. With regard to waivers of conflicts of interest, hedge and waiver clauses should be accompanied by a savings clause, as well as full and fair disclosure of all material information relating to the conflict. What constitutes full and fair disclosure would depend on the client’s sophistication and resources, but best practices would be to err on the side of including detailed explanations of potentially negative consequences to the clients arising out of such conflicts of interest.

3. Private fund advisers should make arrangements for creating and distributing the required Quarterly Statements. Ideally, advisers or their private fund clients already have systems in place creating and preserving records of the required information, so that the additional effort and expense will merely consist of formatting the information appropriately and distributing it to investors. They should verify or, if necessary, amend their internal procedures, so as to require maintenance of the records that will be called for to demonstrate compliance with the new rules.

4. Advisers to private funds should arrange for audits of controlled funds and distribution of audited financials for 2024.

5. Advisers will need to create new internal procedures for creating and maintaining evidence demonstrating the adviser took all reasonable steps to cause any client fund with which it has no control relationship to undergo an audit and distribute audited financial statements. Evidence of a weak attempt may be as bad as having no evidence at all.

6. Private fund advisers should establish and implement internal procedures requiring the adviser to create and maintain records adequately demonstrating that the adviser undertook, and made an affirmative determination, with respect to the materiality of certain information referred to in the Final Rules:

a. the possible material negative consequences for granting redemption privileges to certain clients
b. regarding disclosure of information regarding the portfolio holdings or exposures of the fund to any investor, if such disclosure would have a material negative effect on other investors.
c. information to be provided in a written notice to prospective investors of specific information regarding any preferential treatment related to any material economic terms the adviser or its related persons provide to other investors in the same private fund.

If records do not demonstrate adequate attention to such matters, the adviser could have exposure in an enforcement action.

7. Advisers to private funds should begin making arrangements to obtain fairness or valuation opinions from independent providers that will be required in the future under the new rules.

8. Advisers should refrain from charging fees in connection with any services that the investment adviser does not, or does not reasonably expect to, provide to the portfolio investment. The Commission view is that imposition of such fees is likely inconsistent with Federal fiduciary duties of loyalty and good faith.

9. Private fund advisers, even if they are exempt reporting advisers, should examine their internal compliance procedures to ensure they are conducting, and maintaining records of, their annual internal compliance reviews.

If you are a private fund advisor and you would like to discuss any aspect of these new rules or if you would like us to assist you with assessing your firm’s compliance with these new rules, please feel free to reach out to us.

Natalie Roberts
[email protected]
612-810-0339
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Michael Macaluso
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612-718-4200
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End Notes
Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews. Release No IA-6368 (August 23, 2023) (the “Adopting Release”). In the Adopting Release, the Commission notes that investment advisers’ private fund assets under management have steadily increased over the past decade, growing from $9.8 trillion in 2012 to $266 trillion in 2022. The number of private funds has increased from 31,717 to 100,947 over the same period.
Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews. Release No IA-6368 (August 23, 2023) (the “Adopting Release”). In the Adopting Release, the Commission notes that investment advisers’ private fund assets under management have steadily increased over the past decade, growing from $9.8 trillion in 2012 to $266 trillion in 2022. The number of private funds has increased from 31,717 to 100,947 over the same period.
See,e.g.,CommentsofthePrivateInvestmentFundsForum,SECReleaseNo.IA-5955,FileNo.S7-03-22 (Apr.25,2022),https://www.sec.gov/comments/s7-03-22/s70322-20126625-287267.pdf;Commentsofthe NationalVentureCapitalAssociation,SECReleaseNo.IA-5955,FileNo.S7-03-22(Apr.25,2022), https://www.sec.gov/comments/s7-03-22/s70322-20130106-296800.pdf;CommentsoftheSecuritiesIndustry andFinancialMarketsAssociation,SECReleaseNo.IA-5955,FileNo.S7-03-22(Apr.25,2022), https://www.sec.gov/comments/s7-03-22/s70322-20126748-287461.pdf;CommentsoftheManagedFunds Association,SECReleaseNo.IA-5955,FileNo.S7-03-22(Apr.25,2022),https://www.sec.gov/comments/s703-22/s70322-20126631-287270.pdf;CommentsoftheNationalAssociationofPrivateFundManagers,SEC ReleaseNo.IA-5955,FileNo.S7-03-22(Apr.25,2022),https://www.sec.gov/comments/s7-03-22/s7032220126565-287200.pdf;CommentsoftheNationalAssociationofInvestmentCompanies,SECReleaseNo.IA5955,FileNo.S7-03-22(Apr.22,2022),https://www.sec.gov/comments/s7-03-22/s70322-20126661287366.pdf.
See also https://www.findknowdo.com/news/09/05/2023/trade-associations-sue-vacate-sec-private-fund-adviser-rules (Regulatory Intelligence commentator Steven Lofchie opines that the SEC could lose in lawsuits challenging its authority.) “There are reasonable bases to argue that each of these rules was either based on insufficient cost-benefit analysis and, as to many of the rules, that their adoption is outside the statutory authority of the SEC.”
The industry associations that filed suit were The National Association of Private Fund Managers, Alternative Investment Management Association, American Investment Council, Loan Syndications & Trading Association, Managed Funds Association and National Venture Capital Association.
In the Adopting Release, the Commission itself recognized that private funds play an increasingly important role in the lives of millions of Americans planning for retirement. Individuals have indirect exposure to private funds through participation in public and private pension plans, endowments, foundations, and other retirement plans, all of which invest directly in private funds.
By “lack of governance mechanisms,” the Commission means that “Because the adviser (or its related person) acts on behalf of the fund client and is typically not required to obtain the input or consent of investors in the fund, the governance structure of a typical private fund is not designed to prioritize investor oversight of the adviser and general partner or managing member (or similar control person) or investor policing of conflicts of interest… [P]rotection is necessary because investors face difficulties in negotiating for reformed practices, including stronger governance structures, because of the bargaining power held by advisers and by investors who benefit from current adviser practices, such as investors who receive preferential treatment from their advisers.”
Related Persons means all officer, partners, directors (or any person performing similar functions) of the adviser; all persons directly or indirectly controlling or controlled by the adviser; all current employees other than those performing only clerical, administrative support, or similar functions; and any person under common control with the adviser.
Performance-based compensation means allocations, payments, or distributions of capital based on the private fund’s (or any of its investments’) capital gains, capital appreciation and/or other profit.
Portfolio investment compensation means any compensation, fees, and other amounts allocated or paid to the investment adviser or any of its related persons by the portfolio investment attributable to the fund’s interest, including but not limited to , origination, management, consulting, monitoring, servicing, transaction, administrative, advisory, closing, disposition, directors, trustees or similar fees or payments.
Illiquid funds are those that are not required to redeem interests upon an investor’s request; and have limited opportunities if any for investors to withdraw before the termination of the fund.
Adviser-led secondary transaction means any transaction initiated by the investment adviser or any of its related persons that offers private fund investors the choice between:
(1) Selling all or a portion of their interests in the private fund; and
(2) Converting or exchanging all or a portion of their interests in the private fund for interests in another vehicle advised by the adviser or any of its related persons.
Fairness opinion means a written opinion stating that the price being offered to the private fund for any assets being sold as part of an adviser-led secondary transaction is fair.
Valuation opinion means a written opinion stating the value (as a single amount or a range) of any assets being sold as part of an adviser-led secondary transaction.
Independent opinion provider means a person that: (1) Provides fairness opinions or valuation opinions in the ordinary course of its business; and (2) Is not a related person of the adviser.
Material business relationships is not defined in the Adopting Release.
Portfolio investment means any entity or issuer in which the fund has directly or indirectly invested.
Adviser clawback means any obligation of the adviser, its related persons, or their respective owners or interest holders to restore or otherwise return performance-based compensation to the private fund pursuant to the private fund’s governing agreements.
Preferential treatment granted to certain investors often takes the form of a “side letter,” altering the terms of the fund’s governing agreement, in which the preferential terms are offered to certain prospective investors to induce them to invest. These preferential treatment terms can transfer the cost or risk of investment to the other investors.
Similar pool of assets means a pooled investment vehicle other than in investment company registered under the Investment Company Act, with substantially similar investment policies, objectives, or strategies to those of the private fund managed by the adviser or its related persons. This term does not include securitized asset funds. In the Adopting Release, the Commission intentionally failed to define this term, refusing to limit the definition to funds that invest side by side with the fund at issue, and stated that the term could include an adviser’s proprietary fund, a co-investment fund, or even single investor funds that are ultimately intended to be commingled. However, if the pool of assets has a materially different target return or sector focus, such that it would not have similar investment objectives, would probably be excluded.
The term material, negative effect is not defined in the Proposed Rules, meaning advisers will have to make their own independent evaluations as to whether a negative effect is “material.” There is a body of case law and substantial guidance, however, on the issue of materiality. A facts and circumstances test must be applied. The Supreme Court has defined a fact as “material’ if there is “a substantial likelihood that the . . . fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.”
Material economic terms is not defined but the Adopting Release includes provisions related to the cost of investing, liquidity rights, fee breaks, and co-investment rights as examples of material economic terms.
In Release No. 5248 under the Advisers Act (June 5, 2019), Commission Interpretation Regarding Standard of Conduct for Investment advisers, the Commission discussed advisers’ Federal fiduciary duty, including the duties of care and loyalty, and an obligation to, at all times, serve the best interest of its client and not subordinate its client’s interest to its own.