On February 9, 2022, the SEC proposed new rules and amendments that will have an impact on investment advisors, funds, and what is received by certain investors.
SEC Proposes New Rules on Private Funds to Protect Investors
There are 5,037 registered private fund advisors in a $18-trillion marketplace. The private fund industry continues to evolve and grow in quantity and complexity, and plays an increasingly important part in the financial system.
The SEC revealed plans to:
- Require SEC-registered private fund advisors to provide quarterly statements disclosing information on funds fees, expenses, and performance
- Create new requirements for private fund advisors related to fund audits, books and records, and advisor-led secondary transactions
- Prohibit private fund advisors (including those not registered with the SEC) from sales practices, conflicts of interest, and compensation schemes that are against public interest and the protection of investors, and prohibit them from providing preferential treatment to investors in their funds
- Propose amendments to the Advisors Act compliance rule.
The following rules would apply to private fund advisors registered with the SEC:
- Provide and distribute within 45 days to investors a quarterly statement detailing
- Fees and expenses, including those paid by underlying portfolio investments to the advisor or its related persons
- Standardized fund performance:
- For liquid funds: Annual total returns for each calendar year since inception and the fund’s cumulative total return for the current calendar year
- For illiquid funds: IRR and MOIC (multiple of invested capital), the gross IRR, and the gross MOIC for the unrealized and realized portions of the portfolio, and a statement of contributions and distributions
- Undergo a financial statement audit of each private fund at least annually and upon liquidation, conducted by a PCAOB-inspected independent public accountant
- Obtain an independent fairness opinion when leading an advisor-led secondary transaction and provide a summary of any material business relationships the advisor has had within the past two years
- Must retain books and records related to the proposed quarterly statement rule and the mandatory advisor audit rule, and support their compliance with the proposed advisor-led secondaries rule and the proposed preferential treatment disclosure rule.
The following rules would apply to private fund advisors both registered and unregistered with the SEC:
- Certain sales practices, conflicts of interest, and compensation schemes against public interest and the protection of investors are prohibited, including
- Charging certain regulatory and compliance fees and expenses or fees or expenses associated with certain examinations or investigations
- Charging fees for certain unperformed services
- Charging fees or expenses related to a portfolio investment on a non-pro rata basis
- Borrowing or receiving an extension of credit from a private fund client
- Reducing the amount of any advisor clawback by the amount of certain taxes
- Limiting or eliminating liability for certain advisor misconduct
- Granting preferential terms to certain investors regarding liquidity or transparency such as holdings and exposure is prohibited. Other preferential treatment may be permitted if disclosed to current and prospective investors.
In addition, amendments are proposed that all registered advisors (not just those to private funds) must document the annual review of their compliance policies and procedures in writing.
Cybersecurity Risk Management
With many professionals in the investment industry still working remotely and continuing to deal with the fallout from COVID-19, the tendency to depend on technology for business operations is at an all-time high. As a result, cybersecurity and cyber-attacks need to be examined more closely by all professionals.
The SEC has proposed new rules related to cybersecurity risk management to help with preparedness against cybersecurity threats and attacks. These proposed rules would require advisors and funds to create and implement written policies and procedures to address cybersecurity risks that could harm advisory clients and fund investors or lead to unauthorized access to client or fund information.
The new proposals would also ask advisors and funds to enhance disclosures to their prospective and current clients related to cybersecurity risks and incidents. The proposal would amend Form ADV Part 2A and require disclosure of any cybersecurity risks and incidents. It would also require advisors to maintain records related to cybersecurity risk management rules and any occurrences of cybersecurity incidents.
Finally, advisors would have to report significant cybersecurity incidents to the SEC on a new proposed form, ADV-C. The hope is that this new form will assist the SEC with monitoring the effects of any cybersecurity incidents at advisors while protecting investors.
Reducing Risk in Clearance and Settlement of Securities
In order to increase market efficiencies and reduce the credit, market, and liquidity risks in the clearing and settling process of security transactions, the SEC proposed to require compliance with a T+1 settlement cycle by March 31, 2024 (if adopted).
- Old Rule 15c6-1 amendments:
- Shorten the standard settlement cycle from T+2 to T+1 for broker-dealer security transactions
- Repeal T+4 for certain firm commitment offerings
- New Rule 15c6-2 requirements:
- Broker-dealers: Must complete allocations, confirmations, and affirmations as soon as technologically practicable by end of trade date (T+0)
- Investment advisors: Must properly document allocations and affirmations, and retain confirmations received from broker-dealers
- CMSPs: Must have written policies and procedures to facilitate straight-through processing and submit an annual report to the SEC on progress with the process
- The SEC also solicits comments on how best to further achieving a same-day settlement cycle
The public comment period for these proposals will remain open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer.
We would be pleased to provide further information related to this subject. For more information, contact Ashley Jiang, Senior Accountant, Audit & Accounting at ajiang@kmco.com or Frank Varanavage Manager, Audit & Accounting at Fvaranavage@kmco.com.
