Thursday, September 07, 2023
SEC Adopts New Private Fund Adviser Rules: Application to Exempt Reporting AdvisersBy Mark Heine and Gary Kocher – K&L Gates LLP On August 23, 2023, the U.S. Securities and Exchange Commission (the “SEC”) adopted a number of new rules (the “New Rules”) under the Investment Advisers Act of 1940 (the “Advisers Act”). The New Rules are designed by the SEC to increase investor visibility into adviser practices and to address certain practices that could lead to investor harm. The New Rules impact three categories of investment advisers: (i) all registered investment advisers, (ii) registered investment advisers (“RIAs”) that advise private funds, and (iii) advisers (both registered and non-registered) that advise private funds. As a general matter, advisers that only provide investment advisory services to venture capital funds are not required to be registered with the SEC and are referred to as ‘exempt reporting advisers’ (or “ERAs”). Most , if not all, advisers to angel funds that are organized by or in connection with ACA member groups fall within this category. As such, the focus here is limited to the New Rules that apply to ERAs. The two primary categories of the New Rules that apply to ERAs include (i) certain restricted activities, and (ii) the granting of preferential treatment to certain investors. Restricted Activities. The New Rules include a number of new “restricted activities” that require advisers to comply with certain disclosure and consent requirements if they elect to engage in such restricted activities, as described below:
Preferential Treatment/Side Letters. The New Rules include limitations on an adviser’s ability to provide some (but not all) investors with preferential treatment (often contained in so-called “Side Letters”), as described below:
While the New Rules impose several new obligations, the SEC chose not to adopt certain provisions contained in the proposed rule that had been subject to widespread comment in the industry and fear that adviser liability could be significantly expanded for failures of portfolio companies. Notably, the New Rules omitted the prohibitions from an adviser (i) seeking exculpation and/or indemnification for the adviser’s simple negligence, or (ii) receiving fees for unperformed services (as an example, if an adviser (or an affiliate) is engaged by a portfolio company to provide consulting or other services, the adviser would be prohibited from including a clause in the service contract that would “accelerate” the payment of all remaining (and unearned) fees if the portfolio company is sold prior to the end of the service contract term). Instead, with respect to the receipt of fees for any such unperformed services, the SEC reiterates its position that such conduct is inconsistent with an adviser’s fiduciary duty and therefore violate the Advisers Act antifraud provisions, even if disclosed and/or even with investor consent. The SEC’s position is a good reminder that ERAs, as investment advisers, are bound to federal fiduciary standards and subject to the antifraud provisions under the Advisers Act and the rules thereunder. Finally, it has been widely reported that the New Rule imposes new audit requirements for private funds, but angel fund organizers can breathe easy because this requirement only applies to RIAs to private funds and would not impact the typical angel fund. We will continue to monitor and report on the implementation of the New Rules and the specific implications for ERAs to angel funds. K&L Gates has a large group of attorneys advising fund advisers for public and private funds, as well as investors in such funds. Please feel free to contact Mark Heine (Mark.Heine@klgates.com) or Gary Kocher (gary.kocher@klgates.com) if we can answer any questions. UPDATE! Additional Information from the SEC Released: Click here to read the SEC Rules Chart. Click here to read the SEC Fact Sheet. The above analysis is for general informational purposes only and does not constitute legal advice. Tags: |