United States - Fund Finance (2024)

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EXECUTIVE SUMMARY

On 23 August 2023, the US Securities and Exchange Commission(the SEC) adopted a new set of private fund adviser rules (each aRule and, collectively, the Rules, and the related release, theAdopting Release)¹ that materially increase theregulatory burden placed on investment advisers to privatefunds² under the Investment Advisers Act of 1940, asamended (the Advisers Act), while also providing new rights toinvestors. While not as extensive as the rule package originallyproposed by the SEC in February 2022 (the Proposal),³the Rules will nevertheless have a significant impact on privatefund advisers, the investors in their funds and the private fundsindustry as a whole.⁴ We expect the Rules'disclosure- and consent-based framework and audit and quarterlyreporting requirements will both expand the scope of and add to thesubstantial regulatory burden faced by advisers to private fundsand, together with other rulemaking affecting private fund sponsors(e.g., the Marketing Rule,⁵ Form PFAmendments,⁶ and the proposed SafeguardingRule⁷ ), act as the most significant change in privatefund regulation since the Dodd-Frank Act mandated the registrationof most private fund advisers in 2010. Compared to recentrulemaking activities, the Rules are more expansive in scope andapply to SEC-registered, exempted, and nonregistered advisers.

Many investors—particularly investors without significantnegotiation leverage when facing large private fundmanagers—may welcome the additional disclosure and consentrights provided by the new Rules, as well as the additionalinformation (such as detailed quarterly statements) the Rulesentitle them to receive going forward. However, investors andadvisers alike may find that, counterintuitively, the sunlightafforded by the Rules effectively chills theirrelations.

The Rules dramatically change certain hallmarks of the privatefund space, with regulatory restrictions imposed on the sorts ofterms private fund industry participants are able to negotiate,their pathways of communication, and the information they areentitled (or required) to share. The recalibration ofadviser-investor interactions that will likely follow may prove tobe the most enduring impact of the Rules. And, while the Rulesallow for grandfathering of certain existing private fundarrangements, the Rules still impose a number of new operationaland compliance obligations on investment advisers, includingrequirements to provide very prescriptive quarterly reports.Certain of the Rules also apply only to investment advisersregistered with the SEC (Registered Investment Advisers, or RIAs),while others apply to both RIAs and private fund advisers that areexempt from registration. All RIAs (including those that do notadvise private funds) will also be required to comply with theRules' mandates on compliance reviews.⁸Consequently, all investment advisers will need to familiarizethemselves with the Rules to ensure compliance in advance of theSEC's implementation deadlines.

This guide contains a detailed summary of the Rules, along withpractical considerations for both advisers and investors relatingto compliance and implementation. In Part 1: Scope of the PrivateFund Adviser Rules, we have detailed the applicability of the Rulesto the different types of investment advisers and funds. In Parts2, 3, and 4, we have outlined how the Rules apply to all privatefund advisers, registered private fund advisers, and all RIAs,respectively. A reference chart summarizing implementationdeadlines for each of the Rules can be found in Part 5: Key Datesfor Implementation.

PART 1: SCOPE OF THE NEW PRIVATE FUND ADVISER RULES

The applicability of each Rule will depend on what types offunds an adviser advises, its registration status, its geographiclocation, and other factors. We explore the applicability of theRules to the different types of advisers in Part 1, Section A;Applicability to Different Types of Advisers and to the differenttypes of funds in Part 1, Section B; and Applicability to DifferentTypes of Funds, below. A reference chart summarizing theapplicability of each Rule to the different types of advisers canalso be found below; see Table 1below.

Additionally, the timeline in which advisers will need toimplement the Rules will depend on whether an adviser is a"small adviser" or a "large adviser;" see Part5: Key Dates for Implementation for further details.

A. APPLICABILITY TO DIFFERENT TYPES OFADVISERS

While reviewing the applicability of the Rules to differenttypes of advisers, advisers should bear in mind that, in eachinstance, the Rules are equally applicable to their relatedpersons. The SEC defines a "related person" as (1) allofficers, partners, or directors (or any person performing similarfunctions) of the adviser; (2) all persons directly or indirectlycontrolling or controlled by the adviser; (3) all current employees(other than employees performing only clerical, administrative,support or similar functions) of the adviser; and (4) any personunder common control with the adviser.⁹ The Rules areconsequently equally applicable to those separate entities formedby an adviser in connection with a specific fund, such as thegeneral partner or an affiliated management company.

A reference chart summarizing the applicability of the Rules canbe found at the end of this Part 1.

I. Non-US Fund Advisers

In the Adopting Release, the SEC emphasized that they do notapply substantive provisions of the Advisers Act and the rulespromulgated thereunder—which would include the Rules—tothe nonUnited States (non-US) clients of SEC-registered investmentadvisers whose principal office and place of business is outside ofthe United States (i.e., "offshore advisers"). The SECadditionally clarified that the Preferential Treatment Rule and theRestricted Activities Rule (as each term is definedbelow)¹⁰ would generally not apply to offshore adviserswith respect to their offshore funds, regardless of whether theadvisers are RIAs or if such offshore funds have United States (US)investors.

However, as discussed further in "Similar Pools ofAssets" below, if an offshore fund operates in a parallel fundstructure with a US-based fund, or is a feeder fund in amaster-feeder structure with a US-based private fund, then theadviser to such fund will need to carefully consider theredemption, information and other preferential treatment rightsgranted to investors in the offshore fund, as

investors in such an offshore fund will be entitled to the sametreatment as investors in the onshore fund(s) if such offshore fundis deemed a "similar pool of assets" to the onshorefund(s).¹¹

Registered offshore investment advisers advising only offshorefunds will consequently need to comply only with the ComplianceRule12 amendments. Unregistered offshore investment advisersadvising only offshore funds are not subject to any of theRules.

Practical Considerations

Potential Extraterritorial EffectPotentialExtraterritorial Effect

These clarifications were helpful for many offshore advisersthat were uncertain as to the application of the Rules, as proposedin 2022. However, while not technically applicable to the non-USclients of registered offshore advisers, we expect that there willbe an extraterritorial effect of these Rules going forward asinvestors come to expect private fund documents—irrespectiveof jurisdiction—to include certain of the substantiveprovisions of these Rules. Non-US advisers would consequently bewelladvised to familiarize themselves with the requirements of theRules nevertheless, particularly those Rules concerning which termscan and cannot be granted to investors, going forward (see Part 2:Rules Applicable to All Private Fund Advisers).

Jurisdictions of Funds

As registered offshore advisers are generally subject to lowerregulatory (and other) burdens with respect to their offshorefunds, the additional compliance burdens of the Rules may result insuch advisers increasingly domiciling their US-targeted funds inoffshore jurisdictions such as the Cayman Islands or British VirginIslands, despite the increased financial costs associated withforming and operating funds in such jurisdictions.

II. Registered Investment Advisers

All RIAs will be required to comply with the new amendments tothe Compliance Rule amendments (as discussed further in Part 4:Rules Applicable to All Registered Investment Advisers, below).

Whether an RIA needs to comply with the other Rules13 willdepend on whether it is advising private funds, whether the RIA isUS-based, as well as where its funds are located. All RIAs to"private funds"¹⁴ will need to comply with theCompliance Rule amendments and all of the other Rules, with respectto private funds they advise that are based in the United States(as well as any offshore fund that is a "similar pool ofassets" of any such US private fund, in which case, certainparts of the Preferential Treatment Rule will apply to such funds).However, the compliance requirements for certain Rules will vary,depending on whether such advisers are advising liquid or illiquidprivate funds.¹⁵

RIAs that are based in the United States or that are advising USprivate funds will consequently need to familiarize themselves withall of the Rules.

III. Unregistered Advisers (Including ERAs, ForeignPrivate Advisers, and StateRegistered Advisers)

With the exception of offshore advisers advising offshoreprivate funds (as discussed in Section I. Non-US Advisers,above), two of the Rules, the Preferential Treatment Rule andRestricted Activities Rule, apply to all investmentadvisers to private funds, regardless of whether they are RIAs.This includes those advisers who qualify as "exempt reportingadvisers" (ERA) for purposes of the Advisers Act, including"private fund advisers" and "venture capital fundadvisers."¹⁶

However, advisers that are excluded from the definition of"investment adviser" under the Advisers Act pursuant tosection 202(a)(11) thereof are not required to comply with theRules. Examples of such non-"investment adviser" advisersinclude banks and bank holding companies, government securitiesadvisers, and certain real estate fund managers and single-familyoffices.¹⁷ Because such advisers are not technicallydeemed investment advisers, they are exempted from compliance withthe Rules, even if such advisers, in practice, advise privatefunds.

All other investment advisers exempted from registration withthe SEC pursuant to section 203(b) of the Advisers Act, including"foreign private advisers"¹⁸ and investmentadvisers registered only at the state (versus federal) level, mustcomply with the Preferential Treatment Rule and RestrictedActivities Rule, to the extent they advise US privatefunds.¹⁹

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Footnotes

1. Private Fund Advisers; Documentation of RegisteredInvestment Adviser Compliance Reviews, SEC Release No. IA-6368(Aug. 23, 2023). The Rules were officially published to the FederalRegister, Vol. 88, No. 177 (the Federal Register) on September 14,2023. Any citations to the Rules herein are made with respect tothe Rules as published in the Federal Register. Any citations tothe Adopting Release herein are made with respect to the AdoptingRelease as republished on September 14, 2023 (i.e., as"[c]onfirmed to the Federal Registerversion").

2. In its Adopting Release, the SEC clarified that theRules are intended to apply to "private funds" as suchterm is defined in section 202(a)(29) of the Advisers Act (i.e.,for purposes of the Rules, a private fund is any issuer that wouldbe an investment company, as defined in section 3 of the InvestmentCompany Act of 1940, but for section 3(c)(1) or 3(c)(7) of thatAct). Adopting Release, footnote 4, page 7.

3. Private Fund Advisers; Documentation of RegisteredInvestment Adviser Compliance Reviews, SEC Release No. IA-5955(Feb. 9, 2022).

4. While the Rules will take effect in accordance withthe timeframes set out in Part 5: Key Dates for Implementation,below, we note that a number of private fund industry groups havefiled a petition for review in the United States Court of Appealsfor the Fifth Circuit seeking to vacate and invalidate the Rules.The petition for review alleges, among other things, that the Rulesexceed the SEC's statutory authority and that the SEC adoptedthe Rules in violation of the Administrative Procedure Act. As ofthe date of publication, the petition for review has not affectedthe implementation timeframe for the Rules, as set forth in Part 5,below. As the petition for review was only recently filed, and maynot be resolved before the first of the Rules' compliance datesis reached (see Part 5 for details), advisers to private fundsshould currently proceed as though the Rules will be implemented aspublished.

5. Advisers Act, section 206(4)-1. See alsoInvestment Adviser Marketing, SEC Release No. IA-5653(December 22, 2020).

6. See Form PF; Event Reporting for Large Hedge FundAdvisers and Private Equity Fund Advisers; Requirements for LargePrivate Equity Fund Adviser Reporting, SEC Release No. IA-6297(May 3, 2023).

7. See Safeguarding Advisory Client Assets, SECRelease No. IA-6240 (February 15, 2023).

8. The Rules impact three categories of investmentadvisers: (i) all registered investment advisers; (ii) registeredinvestment advisers that advise private funds; and (iii) advisers(both registered and unregistered) that advise private funds(including exempt reporting advisers). See Table 1 in Part 1 for asummary of the applicability of the Rules.

9. The Rules, section 211(h)(1)-1 (definition of"related person").

10. See Part 2: Rules Applicable to All Private FundAdvisers for details of the Restricted Activities Rule andPreferential Treatment Rule.

11. See "Similar Pools of Assets" in Part 1 forfurther discussion; see also Part 2: Rules Applicable to AllPrivate Fund Advisers.

12. See Part 4: Rules Applicable to All RegisteredInvestment Advisers for further details of the ComplianceRule.

13. I.e., the Preferential Treatment Rule, theRestricted Activities Rule, the Quarterly Statement Rule, thePrivate Fund Audit Rule, and the Advisers-Led SecondariesRule.

14. As such term is used in the Rules; see endnote 2,above, and Section I. Private Funds, Generally in SectionB: Applicability to Different Types of Funds, below.

15. See Part 2: Rules Applicable All Private FundAdvisers for further details.

16. See footnotes i and ii to Table 1. Applicabilityof the Rules to the Different Types of Investment Advisers inPart 1 for further details.

17. The above is a high-level summary of exclusions fromthe definition of "investment adviser"; see section202(a)(11) of the Advisers Act for details.

18. See footnote iii to Table 1. Applicability of theRules to the Different Types of Investment Advisers in Part 1for further details.

19. See Part 2: Rules Applicable to All Private FundAdvisers for further details on the Preferential Treatment Rule andRestricted Activities Rule.

The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circ*mstances.