September 28, 2023 - As previously reported, the SEC has adopted sweeping new disclosure obligations and restrictions on private funds. The Private Fund Disclosure Final Rules (“Final Rules”) will materially impact how private fund advisers and investors structure their relationships. Fortunately, after industry advocacy, CLOs and other asset securitization funds were exempted from all but one of the Final Rules. All registered advisers must at least annually review and document compliance reviews in writing (the “Compliance Review Rule”). For private funds other than asset securitization funds, the Final Rules require:
- Preparation and delivery of quarterly statements (“Quarterly Statement Rule”)
- Annual financial statement audits (“Audit Rule”)
- Restrictions on entering into specified arrangements, including certain fee arrangements, unless certain conditions are met (“Restricted Activities Rule”)
- Restrictions on engaging in adviser-led secondary transactions unless they obtain a fairness or valuation opinion (“Adviser-led Secondaries Rule”)
- Restrictions on entering into tailored arrangements with investors regarding redemption and portfolio rights unless those same arrangement are offered to all other investors
- Restrictions on entering into any other tailored arrangements unless all other investors receive written notice (together, the “Preferential Treatment Rule”).
While our analysis of the 600-plus-page Final Rules continues and will be evolving, below we take a preliminary look at the practical implications of these rules for impacted credit funds (i.e., those formed in reliance on the 3(c)(1) and (7) exemptions in the Investment Company Act). (A complete survey of the requirements of the Final Rules is outside the scope of this piece, but Proskauer has created a comprehensive chart.)
First, the compliance costs imposed by the Final Rules in terms of reporting and developing the systems to support that reporting will be massive. Putting direct costs aside, even though the Final Rules did not adopt many of the aspects that were most concerning to industry the Final Rules will have a meaningful impact. The Preferential Treatment Rule, for instance, means “an adviser will be required to offer preferential liquidity rights and transparency rights to all limited partners, if offered to one limited partner and if those rights would have materially negative impacts on other limited partners.” (Simpson Thacher) This, like many aspects of the Final Rules, relies on vague terms and compliance may not be straightforward. In a credit fund context, this is an area of focus. Where advisers offer enhanced liquidity or transparency rights to certain investors, they will no longer be able to do so unless the adviser can determine that doing so will not negatively impact other LPs. This determination is made with respect to future events – what is reasonably foreseeable as a material negative impact? While separately managed accounts (SMAs) are clearly carved out of the Final Rules, attention must be paid to funds of “similar pools of assets” in the Final Rules, which include certain pooled vehicles that are not private funds. Co-investment rights may need to be taken into consideration in some cases. Recently, Private Debt Investor reported that compliance with the Adviser-led Secondaries Rule may be particularly onerous for credit secondaries where third party valuations may be done on a staggered basis.
It is early days and further implications will certainly emerge, but advisers certainly have their work cut out for them – and that work starts now. Despite pending litigation on the Final Rules, building out the monitoring and reporting capacity required will take time. Likely advisers to private funds will need to start that process now to be certain they are prepared when the compliance period begins in the next 12-18 months.
For more information on this – and many other fascinating topics – come join us on October 12th for the LSTA Annual Conference in NYC. Click here for agenda and registration.
