The SEC has turned its attention to more carefully regulating advisers to private funds, as made clear by new rule proposals released last week. While the proposals are currently in the comment period, it seems likely that most, if not all, of the provisions of the proposed rules will be implemented.

There are three primary facets to the new rules:
  1. Preparation and distribution of statements (with required content) to fund investors.
  2. Requiring audits of all private fund vehicles.
  3. Addressing disparity of investor terms (e.g. side-letters).

The pervasive theme to these proposed mandates is increased transparency to fund investors.

Statements would be required to include a more complete description of adviser compensation, fund fees and expenses, and any fee offsets/rebates/waivers in addition to more specific performance reporting requirements. The SEC has included a provision that allows for this information to be presented differently depending on whether the private fund is liquid (e.g. open-end, hedge) or illiquid (e.g. closed-end, PE/VC), so that investors can more easily compare data from one fund to another. The current proposal is for statements to be provided quarterly, within 45 days of the end of each quarter.

Under the custody rule, most private funds currently undergo an annual audit. However, there are some vehicles that may have used alternative methods in the past. The proposed rules would supersede the custody rule in this context and would require all private funds to undergo an annual financial audit. This could potentially pose a financial burden to some vehicles that hadn’t previously had an audit performed, so it remains to be seen the if the SEC provides some relief for certain fund types (e.g. SPVs).

It is common for fund managers to have special investment terms for founding and/or large investors as an enticement for those investors to participate in the fund. The SEC is concerned that term adjustments involving transparency and/or liquidity preferences for certain investors could be detrimental to the interests of other investors in the fund. Under the proposed rules, managers may be prohibited from certain activities and/or required to disclose certain side-letter terms to the investor base at large. We expect this proposal to be particularly unpopular and it remains to be seen whether it will end up in the final rule.