IAA Statement on SEC Adoption of Final Rules Regulating Private Fund Advisers

August 23, 2023

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Contact:
IAA VP of Communications & Marketing Janay Rickwalder.

Today, the SEC adopted the most significant changes to the regulation of advisers to private funds since the Dodd-Frank Act in 2010. At the same time, the SEC reopened the comment period on its sweeping safeguarding proposal to replace the existing custody rule for advisers. The new rules will no doubt have enormous implications for advisers, private funds, and investors.

The IAA engaged extensively and constructively with the SEC as it considered feedback on the proposed rule, sharing concerns of our members and offering alternatives that would strike a more appropriate balance. Based on our preliminary assessment, and subject to our review and analysis of the 660-page release, we are pleased to see several important modifications to the proposal that appear to address many of the IAA’s concerns.

While the devil will be in the details and we still have significant concerns, the final rules are generally more reasonable than the proposed rules in many respects and better tailored to achieving the SEC’s objectives.

For example, the final rules appear to:

• Apply legacy status for some of the requirements for existing private fund governing agreements, hopefully limiting what would otherwise have been massive disruption of existing negotiated relationships. We will review the release to determine whether the scope of the legacy status is sufficient to protect previously negotiated arrangements from needing to be reopened.
• Instead of imposing outright prohibitions on private fund advisers in all cases, which the IAA strongly opposed, allow for advisers to disclose certain practices to investors or, in some cases, to provide notice and obtain consent. For example, the rules will permit advisers to allocate fees and expenses on a non-pro-rata basis where the allocation is fair and equitable and notice is provided.
• Withdraw the proposed prohibition on indemnification of private fund advisers. This appears to be an important change, for which the IAA advocated. However, the release includes a discussion that “reaffirms and clarifies” application of the fiduciary duty in the private fund context and it is not yet clear how it addresses the SEC’s view on this issue. We will carefully review that discussion to determine whether it is fully consistent with the SEC’s 2019 Interpretation of an adviser’s fiduciary duty.
• As recommended by the IAA, permit a valuation opinion, in addition to a fairness opinion, as an option for an adviser-led secondary transaction. We will review how the SEC’s changes to the preferential treatment rule’s limitations on negotiating certain side letters will impact fund operations.
• Exclude collateralized loan obligations funds from many of the new requirements.
• Provide a longer compliance date for certain aspects of the new rules than was proposed and staggered compliance dates based on an adviser’s assets under management for other aspects. The IAA is increasingly concerned about the disproportionate and rapidly increasing challenges smaller advisers are facing from the sheer scale, scope, and speed of the SEC’s current rulemaking agenda. The challenges are substantial in isolation and potentially overwhelming on a cumulative basis. We appreciate the SEC’s recognition that smaller advisers will need more time to implement today’s new rules. We are concerned, however, that the final compliance runways are too short for all advisers, given the substantial changes they’ll need to make. The IAA will continue to advocate for the SEC to consider the aggregate impacts on all advisers and in particular on smaller advisers and ways it can achieve its policy goals through less burdensome means.

Today’s rulemaking also includes a new requirement that will apply to all advisers, not just advisers to private funds. All advisers will now be required to document their annual compliance review in writing. While the IAA has kept our members informed of this development (which was in the proposal), it may not have been more widely followed outside of private fund advisers. It’s important that all advisers are made aware and understand the importance of this new requirement.

We commend the Commission for reopening the safeguarding proposal to allow commenters to assess its interplay with the new audit rule adopted today. The new rule will require all private fund advisers to undergo an annual audit under the conditions of the existing custody rule. The IAA has pressed the SEC to consider its current rulemaking activity holistically and cumulatively and also provide meaningful opportunity for public feedback on how the various proposals interact with one another.

We look forward to reviewing the release over the coming weeks, engaging with the SEC on interpretive issues, and helping our members understand and prepare for implementation of the new rules.

Private funds offer significant benefits to investors and the capital markets, which include, for example, portfolio diversification and risk management for investors and vital investment capital for companies. It is crucial that the final rules do not disrupt this marketplace to the detriment of investors and the ability of companies to raise capital. Our review of the release will include consideration of these potential impacts.