New SEC Private Equity Rules

On August 23, 2023, an amended version of the rules were adopted by the SEC on a 3-2 party-line vote. Under the final rules, private funds will now be subject to six additional requirements that other investment advisers will not.³

New Rules

1. The “Quarterly Statement Rule”: Private fund advisers are now required to provide quarterly statements to private fund investors. The statements must include broad disclosures regarding costs of investing in the fund and the fund’s performance. The statements must be distributed within 45 days after the end of each of the first three quarters of each fiscal year and 90 days after the end of each fiscal year. If the fund is a “fund of funds,” the deadlines are 75 days and 120 days, respectively.
2. The “Audit Rule”: All private fund advisers are required to undergo an independent financial statement audit, in conformity with Generally Accepted Accounting Principles by an auditor examined by the Public Company Accounting Oversight Board, to be completed within 120 days after the end of each fiscal year.
3. The “Restricted Activities Rule”: Private fund advisers are restricted from engaging in certain compensation schemes, sales practices, and conflicts of interest. Advisers are prohibited from (1) charging or allocating to a private fund fees or expenses associated with an investigation of the adviser by the government, (2) charging the private fund for regulatory, examination or compliance fees or expenses of the adviser, (3) reducing the amount of any adviser clawback by taxes applicable to the adviser, (4) charging or allocating fees related to a portfolio investment on a non-pro rata basis, and (5) borrowing money, securities, or other private fund assets from a client. Under the final rule, unlike the version proposed in February 2022, each of the restricted activities are subject to either consent-based or disclosure-based exceptions.
4. The “Adviser-led Secondaries Rule”: Private fund advisers are required to provide investors with a fairness opinion where the adviser offers fund investors the option between selling their interests in the private fund, and converting or exchanging them for new interests in another vehicle advised by the adviser.
5. The “Preferential Treatment Rule”: This rule is significantly different from the rule proposed in February 2022, which would have prohibited granting any investor in a private fund the right to redeem its interest on terms that the adviser reasonably believes will have a negative effect on other investors in the fund and would have also prohibited providing any information to any investor if the adviser reasonably expects that the information would have a negative effect on investors in the fund. The final rule offers exceptions if the adviser has offered the same redemption ability and/or information to all existing investors.

Criticism and Litigation Concerning the New Rules

Chair Gary Gensler issued a statement in support, noting that “by enhancing advisers’ transparency and integrity, we will help promote greater competition and thereby efficiency in this important part of the markets.”⁴ Commissioners Jaime Lizárraga and Caroline A. Crenshaw also issued statements in support. Commissioner Lizárraga specifically highlighted the inadequacy of existing market forces in protecting the public interest⁵, while Commissioner Crenshaw noted the sheer size of the “capital at risk” in private funds.⁶

In a dissenting statement, Commissioner Mark T. Uyeda argued that, in enacting the final rule, “[t]he Commission relies on questionable statutory authority, fails to consider the aggregate impact of the multitude of rules promulgated since 2022 affecting investment advisers, and dismisses warnings that it will have a disparate impact on smaller advisers, including those that are minority- and women-owned.”⁷ Commissioner Hester M. Peirce also disagreed with adopting the final rule, noting her belief that the new rules are “ahistorical, unjustified, unlawful, impractical, confusing, and harmful.”⁸

Commissioner Peirce is not the only one who believes the rule is unlawful. Litigation has already (and unsurprisingly) arisen over the newly adopted rules. On September 1, 2023, the National Association of Private Fund Managers and others petitioned the U.S. Court of Appeals for the Fifth Circuit for review of the SEC’s decision under 15 U.S.C. § 80b–13. The petition for review alleges that the rules exceed the SEC’s authority, did not comply with notice-and-comment requirements by allowing additional notice and opportunity to comment after changes were made to the rules, and were arbitrary and capricious under the Administrative Procedure Act (with additional considerations required under the Investment Advisers Act).

The Fifth Circuit has not been a friendly forum for the SEC of late. Most notably, in 2022, the court held that certain SEC enforcement proceedings were unconstitutional.⁹ Private funds should take note of these proceedings, which will likely determine whether the rules will go into effect.

When Will the New Rules Go Into Effect?

Barring a stay from the Fifth Circuit or another federal court, they will go into effect 60 days after publication in the Federal Register. After the rules take effect, there will be 18-month transition periods for the Audit Rule and Quarterly Statement Rule. For the Adviser-led Secondaries Rule, the Preferential Treatment Rule, and Restricted Activities Rule, advisers with $1.5 billion or more in assets under management will have 12-month transition periods and advisers with less than $1.5 billion will have 18-month transition periods. In the meantime, private funds to which the new rules are applicable should prepare for compliance, including by seeking legal counsel.

¹ For a more detailed discussion on the rules as initially proposed in February 2022, see https://www.velaw.com/insights/private-equity-private-no-more/.

² Https://www.sec.gov/files/rules/proposed/2022/ia-5955.pdf.

³ Https://www.sec.gov/files/rules/final/2023/ia-6383.pdf.

⁴ Https://www.sec.gov/news/statement/gensler-statement-private-fund-advisers-082323.

⁵ Https://www.sec.gov/news/statement/lizarraga-statement-private-fund-advisers-082323.

⁶ Https://www.sec.gov/news/statement/crenshaw-statement-private-fund-advisers-082323.

⁷ Https://www.sec.gov/news/statement/uyeda-statement-private-fund-advisers-082323.

⁸ Https://www.sec.gov/news/statement/peirce-statement-doc-registered-investment-adviser-compliance-reviews-08232023.

⁹ Jarkesy v. S.E.C., No. 20-61007 (5th Cir. May 18, 2022).