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New SEC Rules for Private Fund Advisors – What You Should Know

In a Wednesday, August 23 open meeting, the SEC voted to approve a set of new rules and amendments to the Investment Advisers Act of 1940 aimed at tightening the regulation of the $18 trillion private funds sector. These are the most significant changes to such rules since Dodd-Frank in 2010 and will undoubtedly reshape certain practices of private fund advisors.

Key Provisions

Under the adoption, private equity firms, hedge funds, and other private fund advisers registered with the SEC will be required to:

• Obtain and distribute to investors an annual financial statement audit of each private fund it advises
• Provide investors (limited partners) with quarterly statements disclosing additional information regarding fund fees, expenses, and performance, in addition to those paid by portfolio companies
• Obtain a fairness opinion in connection with an adviser-led (GP-led) secondary transaction
• Prohibit all private fund advisers from providing investors with preferential treatment regarding redemptions (exiting a fund early) and timing of information via so-called side-letters unless full disclosure of such arrangements is made to all current and prospective investors (or when edemptions are required by law or regulation)

Regarding the preferential information rights, GPs can still offer this information as long as they offer the same terms to every other LP in the fund. This wasn’t included in the proposal but is consistent with the intended goal from the SEC of helping to level the playing field and promote fair competition.

The SEC has given advisers one year to adapt to the new requirements, while those managing less than $1.5 billion have been given 18 months. The commission also included a legacy provision that will allow existing funds to be grandfathered in without having to renegotiate agreements with current investors.

Purpose for the Amendment

In a statement, SEC Chair Gary Gensler said: “Private funds and their advisers play an important role in nearly every sector of the capital markets. By enhancing advisers’ transparency and integrity, we will help promote greater competition and thereby efficiency. Consistent with our mission and Congressional mandate, we advance today’s rules on behalf of all investors – big or small, institutional or retail, sophisticated or not.”

As such, the required audits are expected to provide a check on the advisor’s valuation of private fund assets (i.e., portfolio valuation), enhance comparability, as well as help protect private fund investors against the misappropriation of fund assets. The requirement for distributions of quarterly statements related to information about the cost of investing and performance is meant to heighten transparency and promote greater governance. At the same time, the requirement for fairness opinions is intended to combat any conflicts of interest that may be present in these kinds of secondary transactions, according to the SEC.

What does this mean and what should you do?

As a result of these amendments, many fund advisors will need to transform their practices and implement new operational and management changes.

At Centri, we have experience helping private equity firms and their portfolio companies navigate the changing regulatory landscape. Our cross-functional teams understand the impact this will have on the level of support required for accounting and portfolio valuation, and the internal controls over these procedures. This is especially important if your fund was not previously audited. Similarly, our fairness and solvency opinion practice can plan with you in advance for upcoming transactions that would fall under the new amendment, especially with the increased popularity within the current market environment.

We recommend private funds take a proactive stance to compliance by working with their team of advisors in accounting, administration, and legal to monitor changes and seamlessly transition. Contact us to arrange a call and speak with our team of experts who can give you the information needed to make informed decisions and help you implement industry best practices. We can partner with you and your advisors to navigate these changing tides successfully.

SEC Press Release

Curtis Farrow

Partner | Private Equity & Venture Capital Practice Leader | CPA, ASA

Curtis is a Partner at Centri Business Consulting and the leader of the firm’s Private Equity & Venture Capital Practice. He has more than 11 years of experience and has supported many clients in achieving their growth initiatives in connection with M&A, capital raising, reorganizations, and carve-outs, as well as successful liquidity events for stakeholders via IPOs, de-SPACs, reverse mergers, and other M&A transactions. Curtis joined Centri in November 2019, where he combines his strong expertise in business and intangible valuation with his knowledge of accounting to identify, address, and resolve business issues for investors and entrepreneurs.. View Curtis Farrow's Full Bio

Tori Jancovic

Partner | Audit Support & Readiness Practice Leader | CPA

Tori is a Partner at Centri Business Consulting and the leader of the firm’s Audit Support & Readiness Practice. She has more than 11 years of experience in accounting and audit readiness services. View Tori Jancovic's Full Bio