Are Additional Operating Burdens Coming for Private Fund Managers?

By Andrew K. Sledd, CPA, CFE, Partner

Are Additional Operating Burdens Coming for Private Fund Managers?

New proposed SEC rules target private funds and their managers

In recent years the Securities and Exchange Commission (“SEC”) has had a strong focus on the private fund industry. In February 2022, the SEC announced proposed new rules under the Investment Advisers Act of 1940 (the “Act”) which appear to aggressively target private funds and their managers.

The proposed rules appear to place additional emphasis on sophisticated investors versus the retail investor while increasing visibility into certain private fund practices. The rules also appear to prohibit activity that may be contrary to public interest and increase investor protection. These new rules as currently proposed and further described below should be expected to create additional operating burden to private fund managers.

New Audit Rule for Registered Private Fund Managers

The proposed rule would require registered private fund managers and potentially unregistered or exempt reporting advisers to undergo an annual financial statement audit. While most registered managers are already subject to the requirement as part of the SEC’s Custody Rules, the Act’s proposed reforms would require the auditor to report any report modifications or the termination of the engagement to the SEC. The most important takeaway is private fund managers would no longer be able to take the “surprise audit” or custody examination alternative in lieu of a full financial statement audit.

New Prohibited Activities Rule for Fund Managers

The proposed rules would prohibit fund managers from engaging in certain practices that the SEC believes may be contrary to the protection of investors. These include practices such as:

  • Prohibiting the charging certain fees and expenses to the private fund for unperformed services (i.e. monitoring, servicing, consulting or other fees) however, if the manager may still received fees for those type of services if actually rendered;
  • Prohibiting the charging fees for certain regulatory matters (i.e. fees associated with the manager’s examination by regulatory bodies);
  • Limiting or eliminating the ability to seek reimbursement, indemnification, or limitation of damages for breach of fiduciary duty;
  • Reducing the amount of any clawback for the manager by the amount of certain taxes;
  • Prohibiting the charging certain fees related to portfolio investments on a non-pro rata basis; and
  • Prohibiting from borrowing or receiving credit from a private fund client.

New Preferential Treatment Rule

The proposed reforms would also prohibit fund managers from providing preferential terms to certain investors revolving around withdrawals from a fund or information about portfolio investment or exposures if the manager expects providing that information would have a material negative impact on other investors. It would also prohibit fund managers from providing other preferential terms unless fully disclosed to all current and prospective investors.

New Books and Records Rules and Annual Compliance

The proposed rules include amendments to current book and records rule under the Act. The amendments would allow the SEC to assess a manager’s compliance with the new rules. It would also require all registered managers, including those not managing private funds, to document their annual compliance review in writing.

Manager-Led Secondary Transaction Rule

The proposed rule would require all registered managers to obtain fairness opinion in connection with manager-led secondary transactions. Managers often offer existing fund investors the option to sell or exchange their interests in a fund for interested in another vehicle offered by the same manager. An independent provider would have to opine on the fairness of the pricing being offered to the fund for any assets being sold.

Keiter Insight

Possible Impact of SEC Proposed Rule Changes

If these reforms to the Act are passed as proposed the impacts to the private fund industry would be the most sweeping changes the industry has seen in years. The shift would eliminate a manager’s ability to negotiate with investors and create a more rigid regulatory landscape under which fund managers must operate within. It would also create additional costs and administrative burden on managers and their compliance teams. If passed, the changes to the Act would require all registered managers to comply within one year. We can expect significant push back coming from the Registered Investment Advisory (RIA) industry during the public comment period and Keiter will keep you apprised of the final rules once they are finalized and issued.

For more information on these proposed rules and revisions to the Act, please visit the official release on the SEC’s website.

Keiter’s Financial Services Industry team is closely monitoring these and other possible regulation changes. We will keep you updated so you can plan accordingly. If you have any questions, please reach out to your Keiter Opportunity Advisor or Email | Call: 804.747.0000

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About the Author

Andrew K. Sledd

Andrew K. Sledd, CPA, CFE, Partner

​​Andrew specializes in auditing broker/dealers in securities, non-registered investment funds and registered investment advisers. He is a member of the Firm’s Financial Services Industry team and possesses a comprehensive understanding of SEC and FINRA rules and regulations. Read more of Andrew’s insights on our blog.

More Insights from Andrew K. Sledd

The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.


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