How the 7 New SEC Private Fund Rules Create a Need for Innovation

How the 7 New SEC Private Fund Rules Create a Need for Innovation

by Lincoln Gray, Jason Woon
November 29, 2023

While the newly implemented SEC private fund rules require investment advisors to be more transparent, this is an opportunity for you to embrace innovation and even transform your organization. See how each of the seven new rules may impact you and how you can evolve to become more flexible and resilient in the face of changing regulations.

1. Quarterly Statement Rule

To keep investors more informed and to enhance transparency, this new rule requires investment advisors registered with or required to register with the SEC to distribute certain detailed fund information quarterly to investors. This rule also aims to help investors understand a fund’s relationship with investment advisors. Now, the fund administrator must furnish details about fees paid, fund expenses and investment performance.

What this means to you

Although the specific performance information requirements vary depending on fund liquidity, these proactive steps can help you ensure compliance with the quarterly statement rule:

  • Assess your technology needs.
  • Review metrics and data tracking.
  • Establish clear reporting processes and responsibilities.
  • Implement internal controls.

When this rule will apply

  • The compliance date is March 14, 2025.

Innovation opportunity: Technology-driven transparency

The SEC’s quarterly statement rule is the first step to rethinking transparency. Data integration technology can help you achieve this transparency through better data access and real-time reporting capabilities. Pairing this technology with third-party valuations allows you to deliver clear quarterly statements that provide investors with relevant information and insights that build trust.

As the entire industry invests more efforts into compliance, you can save time and lower costs through reporting, technology and valuations.

2. Audit Rule

In the past, certain advisors with custody of investor assets could opt for a surprise examination instead of engaging an independent auditor to perform a financial statement audit. Private fund advisors (other than advisors to securitized asset funds) registered with or required to register with the SEC must now undergo an annual financial statement audit, per the audit provision under the custody rule. The audit rule requires a registered investment advisor providing indirect or direct investment advice to a private fund to complete this annual audit. An independent public accountant registered with and subject to inspection by the Public Accounting Oversight Board (PCAOB) must perform the audit.

The resulting audited financial statements, prepared according to generally accepted accounting principles (GAAP), must be delivered to investors within 120 days of the fund’s fiscal year end (180 days for funds of funds).

What this means to you

Many investment advisors may not be audit ready. Depending on the size, structure and volume of your activities, these steps can help ensure efficient and effective audits needed to meet required timelines:

  • Determine your audit requirements.
  • Evaluate your readiness.
  • Enhance your internal control structure.
  • Review your policies and procedures.
  • Engage with external auditors to seek guidance and develop a plan.

When this rule will apply

  • The compliance date is March 14, 2025.

Innovation opportunity: Proactive audit strategies

Although audits may not occur until 2025, they could date back to 2024 financials. If your firm may be subject to the SEC’s new audit rule, hiring an auditor now can help you prepare. With the help of a professional audit team, you can also offer your investors the assurance they need to make informed financial/investing decisions. With the expanded compliance requirements, you can use this opportunity to assess your financial reporting functions and determine process improvements.

3. Advisor-Led Secondaries Rule

SEC-registered advisors must now meet specific requirements when initiating an advisor-led secondary transaction. If an advisor offers investors the choice to either sell or exchange all or a portion of their interests in a private fund for interests in another vehicle recommended by the advisor or any related persons, they must also provide a written fairness opinion or a valuation. The advisor must also prepare and distribute a written summary of material business relationships between the advisor, its related persons and the independent opinion provider.

What this means to you

Implementing these requirements can help your investors make informed transaction decisions while you offer them more flexibility and supported access to additional market opportunities:

  • Document material business relationships within your firm and with external parties.
  • Establish transparent allocation procedures.
  • Provide detailed disclosures that educate investors.
  • Monitor regulatory updates.

When this rule will apply

  • Larger advisors (defined as those with $1.5 billion or more in private fund assets under management) must comply by September 14, 2024.
  • Smaller advisors (those with less than $1.5 billion in private fund assets under management) must comply by March 14, 2025.

Innovation opportunity: Meaningful investor protection

With this rule, advisors can opt to conduct a fairness opinion or valuation before executing secondaries. However, it’s important to note that valuations are less time-intensive than fairness opinions. While still ensuring the compliance of these transactions, valuations can save valuable time and resources. This forward-thinking strategy helps you strike the right balance between investor protection and financial prudence.

4. Restricted Activities Rule

This rule introduces advisor restrictions on engaging in certain activities and applies to all advisors to private funds, regardless of registration with the SEC. These restrictions aim to protect investors by promoting transparency and preventing inappropriate financial practices.

What this means to you

As an advisor to a private fund, you may not:

  • Charge private fund clients regulatory, compliance, examination or investigation fees.
  • Reduce clawbacks for taxes.
  • Charge or allocate fees on a non-pro-rata basis.
  • Borrow money, securities or other fund assets from private fund clients.

When this rule will apply

  • Larger advisors must comply by September 14, 2024.
  • Smaller advisors must comply by March 14, 2025.

Innovation opportunity: Enhanced activity monitoring

As you strive to comply with the rule’s requirements and limitations, you can also explore new and better ways to manage and disclose fees, expenses and investment allocations. This includes a control structure preventing restricted activities from misallocation to the private fund.

5. Preferential Treatment Rule

This rule prohibits all private fund advisors from providing preferential investor treatment when it comes to redeeming their money or sharing information about the fund’s investments that could have a negative effect on other investors. The two exceptions to this rule are for redemptions required by law or if the advisor offers the same redemption ability to all existing investors. In addition, there are prohibitions on preferential information rights and limitations on the advance written notice requirement to prospective investors.

What this means to you

To equalize the treatment of all investors, you can:
  • Develop a written disclosure process to outline previous preferential treatments and their impact.
  • Include this disclosure in all relevant offering documents.
  • Send timely notifications to current investors.
  • Continually review and update written disclosures.
  • Educate staff and investors.

When this rule will apply

  • Larger advisors must comply by September 14, 2024.
  • Smaller advisors must comply by March 14, 2025.

Innovation opportunity: Compliance and fairness to investor pool

AI technology is a practical tool that can help you automate the processes around monitoring preferential treatment communications. With automation, you can implement robust disclosure and communication practices while minimizing your team’s manual work.

With ongoing compliance monitoring, you can identify potential breaches and take corrective actions. This proactive approach is key to staying compliant with the SEC’s fair treatment principles while protecting investors.

6. Annual Review Rule

The Annual Review Rule mandates advisors to review and document the adequacy of the firm’s compliance policies and procedures, as well as the effectiveness of their implementation. You must thoroughly document this assessment in writing.

What this means to you

With heightened scrutiny of annual review requirements, take these steps to help fulfill your responsibilities to investors:

  • Conduct comprehensive annual reviews.
  • Assess business changes and affiliates’ endeavors.
  • Review and enhance your written supervisory procedures (WSPs).
  • Conduct internal controls and self-audits.
  • Engage compliance experts and legal counsel.

When this rule will apply

  • The compliance date was November 13, 2023.

Innovation opportunity: External documentation

Outsourcing compliance analysis can facilitate your company’s documentation process and enhance compliance reviews. When combined with analytics, machine learning and artificial intelligence (AI), outsourcing can speed up the issue resolution process and help you identify risk potential in your data.

With this analysis, you can prioritize evaluations of high-risk areas, allowing your firm to allocate resources more efficiently, maximize annual review impact and proactively address potential compliance gaps.

7. Recordkeeping Rule

Registered advisors or those who require SEC registration must now retain specific books and records related to the quarterly statement rule, the audit rule, the advisor-led secondaries rule and the preferential treatment rule.

What this means to you

With robust recordkeeping processes, you can promote accountability and compliance across your firm when you:
  • Develop a comprehensive recordkeeping policy.
  • Train employees in best recordkeeping practices.
  • Implement quality control measures.
  • Retain records for the required timeframe.
  • Conduct annual internal and external audits that focus on compliance matters and changes in business activities for the previous year.

When this rule will apply

  • The compliance date was November 13, 2023, but applicability varies for each specific recordkeeping requirement.

Innovation opportunity: Simple and smart regulatory reporting

By using technology such as electronic document systems and data analytics tools to collect and analyze data from various platforms, you can implement systems that ensure accuracy and transparency. The greatest value of this approach is the ability to identify trends and mitigate compliance risk. With insights into your data, you can also generate activity-tracking reports that satisfy regulatory requirements while keeping investors informed.

New technology allows you to automate many processes that would otherwise cost valuable time and money. These systems also support audits and valuations, eliminate repetitive processes and empower your team to enhance transparency.

Comply With the Private Fund Rules, Innovate and Thrive

Find out how operational process enhancements and new financial software strategies can support compliance under the new SEC rules and drive industry leadership. Contact our investment fund consultants today to learn more about how your firm can navigate these new regulations and take full advantage of opportunities in the evolving regulatory landscape.

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