SEC Proposed Rule Would Impose New Requirements on Registered Investment Advisers and Private Funds

The SEC recently published a proposed rule aimed at increasing protection for investors in private funds. If finalized, the proposed

rule, published on February 9, 2022, would enact changes to regulation of private funds on a level not seen since 2012 when private fund advisers were first required to register with the SEC.

The SEC states that it finds private funds to be “opaque” and that private fund advisers do not provide detailed enough information to investors.The SEC claims that even sophisticated investors cannot make informed decisions without sufficient information. The ultimate impetus behind the rule seems to be the SEC’s contention that there is an unacceptable lack of transparency on costs, performance, and preferential terms, causing an information imbalance between advisers and investors, which, in many cases, it claims, prevents negotiations between funds and investors.

The proposed rule contains a number of changes, some of which would require registered investment advisers to private funds to provide transparency to their investors regarding the full cost of investing in private funds and the performance of the private funds. The proposed rule would also require a registered private fund adviser to obtain an annual financial statement audit of each private fund it advises and, in connection with an adviser-led secondary transaction, an independent fairness opinion.

The SEC is also proposing rules that would prohibit all private fund advisers, including those that are not registered with the SEC, from engaging in certain sales practices, conflicts of interest, and compensation schemes that the SEC believes are contrary to the public interest and the protection of investors. Under the proposed rules, all private fund advisers would be prohibited from providing preferential treatment to certain investors in a private fund - as in so-called “side letters” - unless the adviser discloses the preferential treatment to other current and prospective investors.

Public comments will be accepted for 30 days after the proposed rule is published in the Federal Register, or until April 11th, whichever is later.