If you are a private equity or venture capital fund adviser you should be aware of the proposed package of new rules and amendments that the U.S. Securities and Exchange Commission (SEC) released on February 9, 2022. These proposed changes, which are expected to solicit significant feedback, could certainly increase the compliance burden for private fund advisers.

What are the proposed changes?

Below is a brief summary of the proposed rules that could affect the administration, financial reporting and audit process of investment funds:

• Registered advisers would be required to prepare a quarterly statement that includes certain information regarding fees, expenses and performance for any private fund and distribute that quarterly statement to investors within 45 days after each calendar quarter end.
• Registered advisers would be required to subject all private funds to undergo an annual financial statement audit by an independent public accountant. This could require private funds that previously were only subject to an annual surprise examination to go through a full audit process. The independent public accountant performing the audit would also be required to notify the SEC upon the issuance of a modified opinion and within four business days of resignation or dismissal from, or other termination of, the engagement.
• Both registered and unregistered advisers would be required to provide written disclosures detailing the preferential treatment provided to certain investors (generally negotiated through side letters) to all current and prospective investors; otherwise, the preferential treatment is prohibited

New prohibited activities for fund advisors

The proposal also includes rule changes that prohibit all private fund advisors from engaging in certain activities. Below is a brief summary of these proposed prohibited activities:

• Charging a portfolio investment for monitoring, servicing, consulting, or other fees in respect of any services the investment adviser does not, or does not reasonably expect to, provide to the portfolio investment;
• Charging a private fund for fees or expenses associated with an examination or investigation by a governmental or regulatory authority, as well as regulatory and compliance fees and expenses of the adviser or its related persons;
• Reducing the amount of any adviser clawback by actual, potential or hypothetical taxes applicable to the adviser, its related persons, or their respective owners;
• Seeking reimbursement, indemnification, exculpation, or limitation of liability for a breach of fiduciary duty, willful misfeasance, bad faith, negligence, or recklessness in providing services to the private fund;
• Directly or indirectly charging or allocating fees and expenses related to a portfolio investment on a non-pro rata basis when multiple private funds and other clients advised by the adviser or its related persons have invested in the same portfolio investment;
• Directly or indirectly from borrowing money, securities, or other fund assets, or receiving a loan or an extension of credit, from a private fund client.

The full proposal can be found here. The comment period on the proposal will last 60 days before the SEC issues a final rule. We will be closely monitoring any changes that will affect the audits and financial reporting process for private investment funds once the rules are finalized.

Questions? Contact us.