This spring Latham & Watkins lawyers provided guidance on the US Securities and Exchange Commission’s (SEC’s) new rules for private fund advisers at the firm’s inaugural Texas Private Funds Breakfast Series in Houston. The quarterly series is designed to unite senior members of leading private equity firms and financial sponsors for networking and market-focused insights in the private equity space.

The inaugural event, led by partners Ivana Rouse and Laura Ferrell of the Investment Funds Practice, covered significant changes and compliance requirements that will represent a substantial shift in the regulatory landscape for private fund advisers as well as recent updates to certain existing requirements.

6 Key Takeaways

1. Onerous Investor Reporting: The SEC has adopted new rules that will significantly increase the administrative burden of investor reporting for private funds. Advisers will be required to prepare and distribute detailed quarterly statements to investors, which include a breakdown of fees, expenses, adviser compensation, and performance reporting. Additionally, all private funds will have to undergo an annual audit.
2. Restrictions on Certain Activities: The new rules place restrictions on certain activities and practices, such as charging private funds for specific types of fees and expenses without client disclosure or consent, and allocating fees or expenses related to a portfolio investment on a non-pro rata basis without first determining that such allocation is “fair and equitable under the circumstances” and notifying investors accordingly.
3. Restrictions on Preferential Treatment: The new rules restrict an adviser’s ability to grant preferential treatment to certain investors subject to specified notice and, in certain cases, consent requirements. For example, preferential treatment with respect to material economic terms must be disclosed to the other investors in the private fund. Advisers are also prohibited from providing preferential redemption or information rights that an adviser reasonably expects to have a material, negative effect on other investors in that private fund or in a similar pool of assets, subject to certain limited exceptions.
4. Increased Compliance and Recordkeeping Requirements: Under the new rules, advisers will have to retain records related to the new rules, including quarterly statements, audited financial statements, fairness or valuation opinions, and investor notices and consent solicitations. In addition, advisers are now required to document their annual compliance reviews in writing.
5. Implementation Timeline and Legal Challenges: The compliance dates for the new rules vary based on the size of the private fund adviser and the specific provisions of the rules. There is ongoing litigation challenging the SEC’s authority to implement these rules, with industry trade groups arguing that the SEC has exceeded its statutory authority. However, the rules remain in effect pending the outcome of these challenges.
6. Marketing Rule Clarification: The SEC has issued FAQs to clarify the Staff’s expectations with respect to performance reporting under the Marketing Rule, which took effect on November 4, 2022. Compliance with the Marketing Rule has been a significant focus of recent SEC examinations as well as enforcement actions against firms that have failed to comply with the Marketing Rule.