SEC’s New Transparency Rules for Private Fund Advisers

The Securities and Exchange Commission (SEC) issued a proposed rule under the Investment Advisers Act of 1940 that would bring new audit and reporting requirements as well as prohibit certain actions. The SEC stated that the proposed reforms are to “protect private fund investors by increasing their visibility into certain practices, establishing requirements to address practices that have the potential to lead to investor harm, and prohibiting adviser activity that is contrary to the public interest and the protection of investors.”

The proposed new rules would require: quarterly reporting to investors detailing information about private fund performance, fees, and expenses; an annual audit for each private fund; a fairness opinion distributed to investors in connection with any adviser-led secondary transactions; and prohibitions on certain activities and preferential treatment that result in a material adverse impact to investors.

The SEC is also proposing to require all registered advisers, including those that do not advise private funds, to document the annual review of their compliance policies and procedures in writing. Two of these proposals, the quarterly reporting and annual audit requirement, will greatly increase the accounting and audit requirements for private fund advisors.

Quarterly Statement

The proposal would require registered private fund advisers to distribute quarterly statements to investors that provide a detailed accounting of the private fund’s performance, fees, and expenses paid during the reporting period. The statement must also disclose information regarding compensation or other amounts paid by the private fund’s portfolio investments to the adviser or any of its related persons. The statements would be required within 45 days of the end of the quarter.

The information on the private fund’s performance would be tailored to allow investors to better assess, monitor, and compare their private fund investments. The proposal aims to provide uniformity as to how certain key performance metrics are calculated for enhanced comparability and usefulness to investors. The information would also differ for liquid and illiquid funds.

Private Fund Audit Rule

The proposal would also require registered private fund advisers to obtain an annual audit, conducted by an independent public accountant, for each private fund and cause the private fund’s auditor to notify the SEC upon certain events. The audited financial statements would be distributed to investors promptly after the completion of the audit. An audit would also be required upon liquidation.

The proposed audit requirement is separate and distinct from the Custody Rule, Rule 206(4)-2 under the Investment Advisers Act of 1940, and compliance with the Custody Rule would not necessarily guarantee compliance with the proposed rules. Additionally, in a significant departure from existing rules, the proposed rules do not provide for the option of a surprise examination in lieu of an audit.

Who Falls Under the Proposed Rules?

The proposed rules would apply to both existing governing and contractual agreements and those entered into following the effective date of the rules. They would be applicable to SEC-registered advisors as well as U.S. and non-U.S. private fund advisers currently relying on the SEC’s “exempt reporting adviser” (ERA) exemption.

What Steps Can Advisers Take to Prepare?

The SEC has recently reopened the comment period until June 13, 2022. Advisers should assess their preparedness to comply with the proposals in the event that the rules become final. This assessment should include whether in-house capabilities allow for timely distribution of detailed quarterly statements to investors and the identification of independent public accounting firms that specialize in audits of private funds.

Weaver has significant experience in serving funds and advisors and can assist in compliance with the annual audit requirement as well as make introductions to a number of third party administrators that can provide support for the quarterly statement requirement. Contact us for assistance.

Authored by Jeremy Winkler, CPA. 

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