SEC Private Funds Rule: 5 Must-Know Facts

If you’re in the U.S. investment industry in any capacity, you’ve likely been reading up on the latest SEC ruling that imposes stricter regulations on private fund advisers. The SEC’s Private Fund Adviser rule (the “Rule”) is a set of regulations that govern the activities of investment advisers who advise private funds. The SEC Private Funds Rule was officially adopted by the SEC on August 23, 2023, and it will go into effect on March 23, 2024 with “staggered compliance transition dates depending on the type of rule and the level of an adviser’s private fund assets under management,” according to White & Case LLP.

The Rule applies to all investment advisers that advise private funds, regardless of whether they are registered with the SEC. The Rule includes five main provisions:

• The Restricted Activities Rule prohibits investment advisers from engaging in certain activities that could harm investors, such as charging excessive fees, self-dealing, and conflicts of interest.
• The Preferential Treatment Rule prohibits investment advisers from providing preferential treatment to certain investors, such as giving them early access to information or allowing them to redeem their investments more easily than other investors.
• The Quarterly Statement Rule requires investment advisers to provide quarterly statements to their investors that disclose certain information about the private fund, such as its financial performance and valuation.
• The Audit Rule requires investment advisers to obtain an annual audit of each private fund they advise.
• The Adviser-Led Secondary Rule requires investment advisers to obtain a fairness opinion or valuation opinion before engaging in an adviser-led secondary transaction, such as a sale of interests in a private fund to new investors.

1. The “Why” Behind the SEC Private Funds Rule

The Private Funds Rule is designed to protect investors in private funds by increasing the transparency and accountability of investment advisers. The Rule is also expected to level the playing field for investors by reducing the opportunities for investment advisers to give preferential treatment to certain investors. The SEC specifically noted a current lack of transparency, conflicts of interest between advisers and investors, and poor governance mechanisms built into a typical private fund structure to protect the interests of the investors. 

The Rule has been met with mixed reactions from the investment management industry. Some industry participants have welcomed the Rule, arguing that it is necessary to protect investors and level the playing field. Other industry participants have criticized the Rule, arguing that it is too burdensome and will increase the cost of doing business for investment advisers.

Only time will tell how the Rule will impact the investment management industry. However, it is clear that the Rule is a significant development in the regulation of private funds.

2. Stricter Requirements for Quarterly Reporting

While the provisions listed above may seem pretty clear-cut and self-explanatory, there are a few we wanted to draw additional attention to that may impact commercial real estate GPs more than others. One of those provisions is the quarterly statement provision.

As a GP, you may already provide quarterly statements or reports of some kind to your investors. However, the requirements listed in the new Private Funds Rule are more stringent than what you may typically include. We’ve summarized the requirements below:

• Fund’s financial performance: This includes information such as the fund’s net asset value (NAV), returns, and expenses.
• Valuation of the fund’s investments: This includes information about how the fund’s investments are valued and how the valuation process is conducted.
• Fees and expenses: This includes information about the fees and expenses that are being charged to the fund and how they are calculated.
• Transactions: This includes information about the fund’s trading activity, such as the number and value of securities purchased and sold.
• Distributions: This includes information about the fund’s distributions to investors, such as the amount and timing of the distributions.
• Other information: This includes information that is relevant to the fund’s operations, such as changes in the fund’s investment strategy or changes in the fund’s management team.

The quarterly statement must be distributed to investors within 60 days of the end of the quarter. For example, if the quarter ends on March 31, the quarterly statement must be distributed to investors by May 31.

Here are some additional things to keep in mind about the quarterly statement:

• The statement must be in writing and must be delivered to investors in a way that they can reasonably be expected to receive it.
• The statement must be accurate and complete.
• The statement must be prepared in accordance with the SEC’s rules and regulations.

If you are a general partner who manages a private fund, it is important to understand the requirements of the quarterly statement rule and to ensure that you are complying with these requirements. By doing so, you can help to ensure that your fund is transparent and accountable to its investors.

3. Annual Compliance Audits Now Required

Another key provision that may change the way GPs conduct business is the requirement for an annual audit. The audit rule requires investment advisers to obtain an annual audit of each private fund they advise. The audit must be conducted by an independent public accountant who is registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board (PCAOB).

The audit must cover the fund’s financial statements for the most recent fiscal year and must be conducted in accordance with generally accepted accounting principles (GAAP). The auditor must also issue an opinion on the fund’s financial statements, stating whether they are presented fairly, in all material respects, in accordance with GAAP.

The audit rule is designed to help ensure that the financial statements of private funds are accurate and reliable. The audit also helps to protect investors by providing them with an independent assessment of the fund’s financial condition.

Here are some additional things to keep in mind about the audit rule:

• The audit must be completed within 120 days of the end of the fund’s fiscal year.
• The auditor must be selected by the fund’s board of directors or by a committee of the board.
• The auditor must be independent of the fund and its management.
• The auditor must report any material findings to the fund’s board of directors.

If you are a general partner who manages a private fund, it is important to understand the requirements of the audit rule and to ensure that you are complying with these requirements. By doing so, you can help to ensure that your fund’s financial statements are accurate and reliable and that your investors are protected.

4. Penalties for SEC Private Funds Rule Non-Compliance

If a private funds adviser is found to be non-compliant with the SEC’s Private Fund Adviser rule, the SEC can take a number of enforcement actions, including:

• Cease-and-desist order: The SEC can issue a cease-and-desist order that prohibits the adviser from engaging in the non-compliant activity.
• Injunction: The SEC can file an injunction in court that prohibits the adviser from engaging in the non-compliant activity.
• Civil penalties: The SEC can impose civil penalties on the adviser, up to $500,000 per violation.
• Criminal prosecution: The SEC can refer the matter to the Department of Justice for criminal prosecution.

In addition to the enforcement actions that the SEC can take, a private funds adviser who is found to be non-compliant may also face other consequences, such as:

• Damages: Investors who have been harmed by the adviser’s non-compliance may be able to sue the adviser for damages.
• Reputational damage: The adviser’s reputation may be damaged, which could make it difficult to attract new investors.
• Loss of business: The adviser may lose business from existing investors.

The specific consequences that a private funds adviser faces will depend on the specific facts and circumstances of the case. However, it is important for private funds advisers to be aware of the potential consequences of non-compliance with the SEC’s Private Fund Adviser rule.

Here are some tips for private funds advisers to stay compliant with the SEC’s Private Fund Adviser rule:

• Get familiar with the rule: The first step is to get familiar with the rule. The SEC has a number of resources available to help advisers understand the rule, including the rule itself, FAQs, and enforcement actions.
• Implement compliance procedures: Once you understand the rule, you need to implement compliance procedures to ensure that you are in compliance. These procedures should be tailored to your specific business and should be regularly reviewed and updated.
• Get help from a lawyer: If you are unsure about how to comply with the rule, you should get help from a lawyer who is experienced in securities law. A lawyer can help you develop and implement compliance procedures and can advise you on any potential risks.

By following these tips, private funds advisers can help to ensure that they are in compliance with the SEC’s Private Fund Adviser rule and protect themselves from the consequences of non-compliance.

5. The SEC Private Funds Rule’s Impact on Commercial Real Estate