On August 23, 2023, the U.S. Securities and Exchange Commission (SEC) adopted significant rules (each, a Final Rule)1 that will alter the regulatory landscape for private fund advisers and institutional investors. The rules as adopted are narrower in scope than those the SEC proposed in early 2022 (the Proposed Rules)2 but nonetheless will impact how certain terms are granted to investors and the types of information that private fund advisers must share with them.
Some of the Final Rules apply to all private fund advisers, whether registered or not with the SEC.
Highlights include the following.
Preferential treatment.3 The Final Rule on preferential treatment is already generating significant attention. As raised initially in the Proposed Rules, the Final Rule precludes preferential treatment in terms of favorable economic terms, redemptions, and account transparency.
- Preferential economic terms. No private fund adviser may provide certain investors with preferential material economic terms unless the adviser provides advance written notice to prospective investors and written notice to current investors. “Material economic terms” include the cost of investing, liquidity rights, fee breaks and co-investment rights (if they provide materially different fee and expense terms from those of the main fund), but this list is not exhaustive. All private fund advisers are required to annually disclose to existing investors all preferential treatment provided by the advisers since the last annual notice.
- Prohibited preferential redemptions. No private fund adviser may give certain investors preferential redemption rights if the adviser reasonably expects that preferential rights would have a material, negative effect on other investors in the private fund or in a “similar pool of assets” (see “Similar pool of assets” below). If so, then the adviser must offer the same rights to all investors. However, an adviser may offer an investor preferential redemption rights if the investor’s ability to redeem is required by applicable laws, rules, regulations or orders of any relevant foreign or U.S. government, state or political subdivision to which the investor, private fund or any similar pool of assets is subject. This exception does not permit preferential treatment based merely on an investor’s internal policies.
- Prohibited preferential transparency. No private fund adviser may provide certain investors with information regarding the portfolio holdings or exposures of the private fund or a similar pool of assets if the adviser reasonably expects that providing the information would have a material, negative effect on other investors in the private fund or in a similar pool of assets, unless the adviser offers the information to all existing investors in the private fund and any similar pool of assets at the same, or substantially the same, time. The SEC here clearly is focused on open-end funds (e.g., hedge funds) since “the ability to redeem is an important part of determining whether providing information would have a material, negative effect on other investors."4 With respect to closed-end funds (e.g., PE and VC funds), the determination of whether preferential information has been provided to an investor will require a “facts and circumstances analysis.”5