SEC Proposed Private Funds Rule Changes

On February 9, by a vote of three to one, the Securities and Exchange Commission (SEC) proposed five sweeping new rules governing private funds. The comment period on the proposal expires 60 days from February 9 or 30 days from publication in the Federal Registerwhichever comes first.

Some of the proposals would only apply to registered or required advisers; other proposals would apply to all advisers, even those who are exempt from registration.

1. Quarterly Reporting Requirement.

Advisors registered or required to be registered would be required to provide investors in the private funds they manage with certain information. This requirement would be triggered after six months of fund operation and would require statements to be delivered within 45 days of the end of each quarter. Delivery should be made to the private fund’s investors, not just the private fund itself. Required quarterly disclosures include (all terms in italics are defined in the proposed rule, available at Advisers Act Rel. 5955):

A. A so-called “table of funds”, containing the following information:

  1. “A detailed account of all fees, commissions and other amounts allocated or paid to the investment adviser or any of its related persons by the fund during the reporting periodwith separate line items for each allocation or payment category reflecting the total dollar amount, including but not limited to management, advisory, sub-advisory, or similar fees or payments, and performance-based compensation.”

  2. “A detailed accounting of all fees and expenses paid by the private fund during the reporting period . . . , with separate line items for each category of fee or expense reflecting the total dollar amount, including but not limited to organizational, accounting, legal, administrative, audit, tax, due diligence fees and expenses reasonable and travel. »

  3. “The amount of any offsets or rebates deferred during the reporting period in subsequent periods to reduce future payments or allocations to the advisor or its related persons.”

B. A so-called “fund investment table”, containing the following information:

  1. “A detailed accounting of all remuneration of portfolio investments awarded or paid to the Investment Advisor or one of its related persons speak hedged portfolio investment during the reporting periodwith separate headings for each category of allowance or payment reflecting the total dollar amount, presented both before and after the application of any offset, rebate or waiver.”

  2. “The percentage ownership of the fund in each of these hedged portfolio investment from the end of reporting periodor zero, if the fund does not hold a stake in the hedged portfolio investmenttogether with a brief description of the fund’s investment.”

  3. “[P]material disclosure regarding how all expenses, payments, allowances, rebates, waivers and offsets are calculated and include cross-references to sections of the private fund’s organizing and offering documents that set forth the applicable calculation methodology. »

C. Performance Information:

Different performance information would be required depending on whether the fund is liquid or illiquid. An illiquid fund is defined as a fund that: “(i) has a limited life; (ii) does not raise capital continuously; (iii) is not required to repay interest at the request of a investor; (iv) has a predominantly operating strategy of returning the proceeds of disposition of investments to investors; (v) has limited opportunities, if any, for investors to exit prior to fund termination; and (vi ) does not regularly (directly or indirectly) acquire as part of its investment strategy publicly traded securities and derivatives.” Any fund that does not meet the definition of an illiquid fund is a liquid fund.

Funds must present consolidated information for all substantially similar funds “to the extent that it would provide more meaningful information to investors in the private fund and would not be misleading”. Funds must also disclose “the criteria used and the assumptions used to calculate performance”.

1. A liquid fund must report the following information on a quarterly basis:

a. “Total net annual returns for each calendar year since inception;”

b.”Average annual net total returns over the periods of one, five and ten calendar years;” and

vs. “The cumulative net total return for the current calendar year at the end of the last calendar quarter covered by the quarterly statement.”

2. An illiquid fund must report the following information on a quarterly basis:

a. Complex information on rate of return and adjusted investment capital.

2. Submission of audited financial statements.

All private funds managed by a registered adviser or required to be registered should be audited by an independent firm and member of the PCAOB. For US-based funds, the audit must comply with GAAP requirements; foreign funds must comply with substantially similar requirements. Audited financial statements must be delivered “promptly” after completion to investors in the fund. The auditor would be required to notify the SEC if he issues a qualified opinion, resigns or is fired.

3. Practices prohibited to all private fund advisers, even exempt from registration, include:

A. Billing for services not provided: “Charge a portfolio investment for monitoring, service, advisory or other fees relating to services which the investment adviser does not provide or does not reasonably expect to provide to the portfolio investment; »

B. Billing to Defend an Inspection or Investigation: “Charge the Private Fund for any fees or expenses associated with any examination or investigation of the Advisor or its related persons by any governmental or regulatory authority; »

C. Charging Compliance Fees: “To charge the Private Fund for any regulatory or compliance fees or expenses of the advisor or its related persons;”

D. Reduce recoveries: “Reduce the amount of any advisor recovery by actual, potential or hypothetical taxes applicable to the advisor, its related personsor their respective owners or interest holders; »

E. Coverage Provisions: “Seeking reimbursement, indemnification, exoneration or limitation of liability by the private fund or its investors for breach of fiduciary duty, willful misconduct, bad faith, negligence or recklessness in rendering services to the private fund;”

F. Billing or allocation other than pro rata: “To invoice or allocate the costs and expenses related to a portfolio investment (or potential portfolio investment) on a disproportionate basis where multiple private funds and other clients advised by the adviser or its related persons have invested (or intend to invest) in the same portfolio investment;:

G. Borrowing from a fund: “Borrowing money, securities or other assets of a private fund, or receiving a loan or extension of credit, from a client of a private fund. “

H. Preferential redemption rights (subject to the note below): “Granting to an investor in the private fund or in a substantially similar set of assets the ability to redeem its ownership interest on terms that the adviser reasonably expects to have a material adverse effect on other investors in that private fund or a substantially similar set of assets;”

I. Preferential Disclosure of Information (subject to note below): “Providing information regarding portfolio holdings or exposures of the private fund, or a substantially similar set of assetsto any investor if the adviser reasonably expects that providing the information would have a material adverse effect on other investors in that private fund or a substantially similar set of assets.”

NOTE: Preferential treatment is permitted if the adviser does not believe that such treatment will have a material adverse effect on investors in the private fund or substantially similar pools of assets, provided that the preferential treatment is disclosed in advance and in writing to all private fund investors. relevant private funds and such investors also receive annual written reminders of the preferential treatment.

4. For transactions that allow investors in a private fund managed by or required to be a registered adviser to sell or convert their holdings to the adviser or a person related to the adviser, an independent fairness opinion should be issued as and a summary of the terms of the proposed transaction.

5. The annual compliance review that all registered advisers must perform will now have to be in writing, with the writing retained and subject to SEC inspection

Allison Yacker and Lance Zinman also contributed to this update.

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