Private funds and their advisors manage over $18 trillion in assets today. As fewer companies have gone public, sophisticated investors know to look beyond the public market to find great potential companies to invest in. This shift was bound to catch the eye of regulators. The latest round of updated regulations from the SEC signal where their concerns lie and how they believe they can mitigate risk around those concerns. 

The newly adopted 2023 reforms aim to fortify safeguards for private fund investors through heightened transparency, addressing practices that could potentially harm investors, and curbing activities incongruent with public interests and investor protection. Keep in mind that these reforms would apply to registered private fund advisors but not all of them apply to ERA/VC or private fund advisors that manage under $150M AUM. 

TL;DR Concerns & Changes for Financial & Fund Advisors

Enhanced Reporting: Registered private fund advisers will be mandated to deliver quarterly statements detailing private fund performance, fees, and expenses to investors.

Auditing Obligations: Registered private fund advisers will be required to facilitate annual audits for each private fund, with the auditor notifying the SEC in specific instances.

Fairness in Adviser-Led Secondary Transactions: In transactions led by advisers, they will need to provide investors with a fairness opinion and a summary of significant business relationships between the adviser and the opinion provider.

Mitigating Harmful Activities: All private fund advisers, regardless of registration status, are restricted from participating in certain activities detrimental to public interest and investor protection.

Preferential Treatment Curbed: The update prevents private fund advisers from granting preferential terms to specific investors concerning redemptions and portfolio information, unless disclosed to all investors. This one applies to ERA/VC or private fund advisors that manage under $150M AUM too.

Strengthened Compliance Measures: All registered advisers, including those not advising private funds, would be mandated to document their annual compliance policy review in writing.

Here are few of the most salient items for your consideration:

Quarterly Statement Mandate

At the heart of the recently adopted reforms lies the requirement for registered private fund advisors to furnish investors with comprehensive quarterly statements. These statements will outline all fees and expenses incurred by the private fund during the reporting period. Moreover, the statements would unveil information regarding compensations or payments derived from the private fund’s portfolio investments to the adviser or its related entities.

In addition to fee disclosure, the proposal entails furnishing investors with private fund performance insights. 

Liquid funds would be asked to report on: 

• annual net total returns since inception, 
• average annual net total returns over specific time frames, and 
• quarterly net total returns for the ongoing calendar year. 

Illiquid funds would be asked to report on: 

• the gross and net internal rate of return 
• the gross and net multiple of invested capital to capture performance from the fund’s inception up to the current quarter’s close.

Impact for Fund Managers – Additional reporting is likely to require additional staff or an assist from an outside fund administrator to keep financial records easily accessible and accurate. 

Impact for Financial Advisors – Additional statement processing to keep this data up to date can push office staff needs higher. The additional data allows you and your clients better insight into which private investments are performing as expected, falling short or exceeding expectations. 

Elevated Accountability through Private Fund Audit Directive

The new directive stipulates that registered private fund advisors should facilitate financial statement audits for the private funds they oversee, both annually and upon liquidation. These audits, distributed to investors promptly after completion, serve as a critical mechanism to verify the adviser’s valuation of private fund assets. This valuation often forms the basis for calculating adviser fees and acts as a safeguard against potential misappropriation of fund assets.

Impact for Fund Managers – Mandating additional audits can significantly increase the internal fund expenses. Additionally, your firm would need a reliable and experienced auditor to provide timely reviews. Distributing the audit to your investors also increases your Investor Relations needs. 

Impact for Financial Advisors – More reports mean more statement processing and client education to help them understand the implications of the information.

Advancing Equity through Adviser-Led Secondaries Protocol

In the realm of adviser-led secondary transactions, a critical alteration requires registered private fund advisers to procure a fairness opinion. This opinion, provided by an independent entity, would evaluate the fairness of prices offered to the private fund in the context of such transactions. Additionally, advisers would be accountable for revealing material business relationships between the opinion provider and the adviser, further ensuring transparency and minimizing potential conflicts of interest.

Impact for Fund Managers – Partnering with an outside diligence provider will be central to the creation of this fairness opinion. There’s opportunity here for those who provide research to offer their findings to managers, the details of which need to be disclosed to investors.  

Impact for Financial Advisors – One of the hardest parts of offering private investment detail to clients is research – it’s pricey and often not timely. This change could help advisors provide much more detail to their clients about potential investments, however, staying organized around the details and communications requires workflows and support systems. 

Mitigating Potentially Detrimental Practices through Prohibited Activities Regulation

The new legislation seeks to curb practices that stand contrary to public interest and to increase investor protection. 

Prohibited practices would include:

• “Charging certain fees and expenses to a private fund or its portfolio investments, such as fees for unperformed services (e.g., accelerated monitoring fees) and fees associated with an examination or investigation of the adviser;
• Seeking reimbursement, indemnification, exculpation, or limitation of its liability for certain activity;
• Reducing the amount of an adviser clawback by the amount of certain taxes;
• Charging fees or expenses related to a portfolio investment on a non-pro rata basis; and
• Borrowing or receiving an extension of credit from a private fund client”

Impact for Fund Managers – Disclosing as much as possible about your fee structure is crucial. Make sure your sub docs provide clear information and are updated appropriately if you have previously used provisions for accelerated monitoring fees.

Impact for Financial Advisors – Keeping the client’s needs firmly above the advisor’s needs is central to being a fiduciary. This regulation is designed to keep your client first and should fall right in line with your values and best practices.

Fortifying Compliance through Rule Amendments

To ensure comprehensive adherence to the regulatory framework, amendments to the compliance rule under the Advisers Act are suggested. These amendments necessitate all registered advisers, irrespective of their involvement with private funds, to meticulously document their annual compliance policy review in written form.

Impact for Fund Managers – This one makes sense and is likely something you are already doing as a best practice, but documenting the review for future reference will be key.

Impact for Financial Advisors – Just like Fund Managers, you are likely already reviewing your compliance manual. Make sure you’re documenting and keeping track of revisions. 

Promoting Informed Decision-Making and Investor Protection

These updated rules and rule amendments aim to enhance the quality of information accessible to fund investors, enabling them to better evaluate, monitor, and compare their private fund investments. By fostering transparency, accountability, and fairness within the private fund sector, these reforms intend to bolster investor confidence and ensure stricter protection of their financial interests.

The proposed reforms reflect a concerted effort by the Securities and Exchange Commission to demonstrate the increased interest in private investing. As they seek to usher in an era of heightened transparency, accountability, and investor protection through enhanced reporting practices, audits, and upholding fairness standards, these measures aspire to foster an environment in which investor clients can make informed decisions and confidently navigate the complex landscape of financial markets. How much clarity is your firm providing to investor clients?