Understand the U.S. SEC’s final rules governing private fund advisers

What middle market investment advisers need to know and next steps

Sep 07, 2023

The U.S. SEC issued its final rules expanding the regulation of private fund advisers. 

These rules, intended to protect private fund investors, affect all investment advisers.

Middle market investment advisers can take key actions now to mitigate compliance risk. 

Financial services

The U.S. Securities and Exchange Commission on Aug. 23 adopted new rules aimed to expand the regulation of private fund advisers. According to a news release from the SEC, “The new rules and amendments are designed to protect private fund investors by increasing transparency, competition, and efficiency in the private fund market.”

These rules will require registered advisers to private funds to provide quarterly statements to investors, obtain annual audits of the private funds they advise, and obtain either a fairness opinion or valuation opinion in connection with any adviser-led secondary transaction.

Additionally, the new rules will restrict and prohibit certain activities that will apply to all private fund advisers, and will also require all registered advisers, including those that do not advise private funds, to document the annual review of their compliance policies and procedures.

While largely consistent with the SEC’s original proposal from February 2022, the final rule amendments include many modifications and exclude some of the more controversial proposals.

Here are the most salient rules for the middle market:

Quarterly statements: Registered private fund advisers must provide quarterly statements to private fund investors that include certain prescribed, fund-level information regarding performance, the cost of investing in the fund, fees, and expenses paid by the fund, as well as certain compensation and other amounts paid to the adviser. In a change from the proposal, fund advisers will have additional time to distribute fourth-quarter statements, and funds of funds will have additional time to provide investors with quarterly statements.

While advisers will have 18 months after publication in the Federal Register to begin complying with the new quarterly statement rules, we recommend advisers compare current quarterly reporting practices to the newly prescribed requirements. Keep in mind illiquid funds will have to report certain inception-to-date performance and contribution/distribution information.

Audit requirement: The final rule requires audits of private funds advised by registered investment advisers. These audits must meet the requirements of the audit provision in the custody rule of the Investment Advisers Act of 1940. This means private funds currently within the scope of an advisers surprise exam will need to prepare for annual audits, as the surprise exam will not satisfy this new audit requirement.

Adviser-led secondaries: The final rule requires private fund advisers to obtain a fairness opinion or a valuation opinion during adviser-led secondary transactions. This is a change from the proposal, which did not include the option to obtain a valuation opinion. The definition of an adviser-led secondary transaction is relatively broad and includes any transaction initiated by the adviser or its related person that offers private fund investors the choice between selling their interest in a private fund or converting/exchanging their interests from one fund to another vehicle advised by the adviser.

Restricted activities: In a change from the initial proposal, which would have strictly prohibited the following activities, the final rule will allow an adviser to perform these activities either with the consent of the private fund investors or through appropriate disclosure:

  1. Charge the private fund the expenses associated with an investigation of the adviser by any governmental or regulatory authority (consent required). The allocation of these expenses would be strictly prohibited if the investigation results in a sanction for violating the Advisers Act.
  2. Charge the private fund any expenses associated with an examination of the adviser (disclosure required).
  3. Reduce the amount of any adviser clawback by the amount of taxes applicable to the adviser (disclosure required).
  4. Charge the private fund expenses related to a portfolio investment on a non-pro rata basis when multiple private funds or clients advised by the adviser have invested in the same portfolio investment (disclosure required).
  5. Borrow money, securities or other private fund assets from a private fund client (consent required).

It may be welcome news that, in another change from the proposal, the final rule includes grandfather status for existing funds by exempting them from complying with the provisions requiring investor consent.

Preferential treatment: Investment advisers to private funds are prohibited from providing liquidation preferences and information rights to an investor if the adviser reasonably expects such rights and information would have a material, negative effect on other investors in the fund. However, in a change from the proposal, these activities would be allowed if such redemption and information rights are afforded and disclosed to all investors. Any other preferential treatment, as may be achieved through side letters, would be prohibited unless notice of such treatment is provided to all prospective and current investors. Similar to the restricted activities requirements, the final rule allows the grandfathering of existing preferential treatment so that the new rule will apply only to agreements entered into after the rule’s compliance date.


The final rule has a staggered compliance date; the new audit requirement and quarterly statement rules will go into effect 18 months after the publication in the Federal Register. The adviser-led secondary, preferential treatment, and restricted activities rules have a 12-month compliance date for advisers with $1.5 billion or more in private fund assets under management, and an 18-month transition period for advisers with less than $1.5 billion.

Key actions to mitigate compliance risk

It is imperative that registered advisers work with their compliance team and legal counsel to make sure they understand the nuances of the SEC’s new rules and amendments. Take these actions now to mitigate compliance risk:

  • Work with your internal finance team or administrator to understand what information is currently being communicated to investors quarterly and what changes will be necessary to comply with the new rules.
  • Take inventory of pooled investment vehicles you manage that are not currently audited and engage with an auditor to keep them in scope; audits of existing entities may require more effort in the first year to understand historical transactions.
  • Avoid delays in secondary transactions by engaging early with legal counsel and valuation firms to obtain fairness and valuation opinions.
  •  Identify the activities and agreements into which you routinely enter and engage with legal counsel to understand how they may be affected by the new requirements for consent.

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