Irwin Menken

Regulatory Compliance Update

C3 Compliance is providing the following information to assist fund managers in understanding and planning for current and upcoming changes in SEC compliance requirements. This is summary information only. Contact us for detailed guidance and a professional assessment of your needs.

SEC Floats Sweeping New Rules Impacting Private Fund Advisers

On 9 February 2022 the Securities and Exchange Commission proposed a set of new rules under the Investment Advisers Act of 1940, including new cybersecurity risk management rules. If implemented, these rules would significantly increase advisers’ reporting and compliance requirements and prohibit certain commonly accepted practices in the private funds marketplace.

New Requirements

Cybersecurity. The proposed rules would require investment advisers to institute written cybersecurity policies and procedures to address risks that might harm clients and investors; maintain documentation of related policies and incidents; and publicly disclose risks and significant cybersecurity incidents and report such incidents to the SEC. Specific rules and amendments for cybersecurity risk management would include:

  • Periodic, detailed risk assessments
  • Institution of security and risk management controls, including user authentication, standards of behavior, need-to-know access policies and more
  • Monitoring and protection of information systems
  • Institution of measures to detect, respond to and recover from a cybersecurity breach
  • A requirement to report any “significant adviser cybersecurity incident” to the SEC on a proposed Form ADV-C
  • Enhanced adviser disclosures on Form ADV Part 2A of anything that could materially affect their advisory services or cause substantial harm to the adviser or its clients.

Disclosure. The Proposed Rules would require private fund advisers to provide investors with quarterly, standardized statements with detailed information about fees, expenses and performance. Required information would include:

  • A table showing fund-wide reporting, thus allowing investors to compare costs of different private funds, including compensation, fees, offsets, and rebates
  • A table showing all portfolio investments that paid the adviser, including the total amount of portfolio investment compensation and the private funds’ ownership percentage of each portfolio investment
  • Standardized fund performance information, including gross and net internal rate of return (IRR) and multiple of invested capital (MOIC) for illiquid funds and average annual returns for liquid funds.

Annual Audit. Registered private fund advisers would be required to obtain a financial statement audit for each fund at least once a year, and upon a fund’s liquidation, performed by an independent public accountant in accordance with GAAP rules, for prompt distribution to current investors.

Prohibitions

The Proposed Rules would prohibit:

  • Preferential treatment of a private fund investor to the possible detriment of other investors
  • Adviser-led secondary transactions with respect to any private fund without a fairness opinion from, and disclosure of any relationship of the adviser’s with, an independent opinion provider
  • Reducing an “adviser-clawback” (“GP clawback”) amount by taxes applicable to the adviser
  • Seeking from a private fund or its investors reimbursement, indemnification, or limitation of the adviser’s liability for a breach of fiduciary duty
  • Charging a portfolio investment fees for any services not provided by the adviser
  • Charging a private fund for regulatory or compliance expenses, or for fees or expenses incurred by the adviser for a government examination or investigation of the adviser
  • Charging fees or expenses related to a portfolio investment on a non-pro rata basis when multiple private funds and other clients advised by the adviser have invested or propose to invest in the same investment
  • Borrowing money, securities or other fund assets, or receiving an extension of credit, from a private fund client

Retention of records

The Proposed Rules would also require private fund advisers to retain records concerning all the above proposals and to document in writing their annual review of the adequacy of their compliance policies and procedures.

More detail on all of the above is available at the following links:

The SEC’s Private Fund Proposed Reforms Fact Sheet and Proposed Rule

The SEC’s Cybersecurity Risk Management Fact Sheet and Proposed Rule

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