On August 23, 2023, the U.S. Securities and Exchange Commission (SEC) adopted or amended rules under the Investment Advisers Act of 1940 (Advisers Act) that impose significant new obligations on advisers to private funds.¹ This alert outlines the new obligations for advisers to venture capital and private equity funds, including funds of funds.²

Summary

The chart below summarizes the new and amended substantive rules applicable to private fund advisers.

Rule	Summary	Compliance Date
Rules Applicable to All Private Fund Advisers
Preferential Treatment Rule	Disclose preferential treatment of fund investors, including pre-admission disclosure of material, economic preferential treatment	12 months or 18 months (see below) Limited exclusion of legacy funds for information sharing and redemption
	Preferential sharing of information to fund investors is prohibited if there is a reasonable expectation that it could have a material, negative effect on other fund investors
	Preferential redemption of fund investors is prohibited if there is a reasonable expectation that it could have a material, negative effect on other fund investors, unless the redemption is required by applicable law or offered to all investors
Restricted Activities Rule	Regulatory and compliance expenses charged to fund must be disclosed on a quarterly basis	12 months or 18 months (see below) Limited exclusion of legacy funds for investigation expenses and borrowing
	Expenses associated with government investigations cannot be charged to fund unless fund investors consent
	Expenses associated with government investigations that result in an Advisers Act sanction cannot be charged to fund, regardless of fund investor consent
	Portfolio investment expenses for co-investments made by multiple funds must be allocated pro rata among funds, unless non-pro rata allocation is fair and equitable, and disclosed to fund investors
	If clawback obligations are reduced by actual or deemed tax amounts, the amount of the reduction must be disclosed to fund investors
	Advisers cannot borrow money or assets from fund
Rules Applicable Only to Registered Investment Advisers
Annual Audit Rule	Funds must provide annual audited financial statements	18 months
Quarterly Statement Rule	Funds must provide detailed quarterly disclosures, including performance information and many expenses	18 months
Adviser-Led Secondaries Rule	Adviser-initiated transactions that require a fund investor to choose between selling or converting its fund interest must be accompanied by a fairness opinion or valuation opinion, as well as certain disclosures	12 months or 18 months (see below)

New Rules for All Private Fund Advisers

Advisers to private funds, regardless of their registration status, must comply with the new preferential treatment and restricted activities rules.

Preferential Treatment Rule³

The new preferential treatment rule requires private fund advisers to disclose, and in some cases completely prohibits, preferential treatment among investors in private funds.

Disclosure of Preferential Treatment

The preferential treatment rule requires advisers to provide written disclosure to all fund investors of preferential treatment provided to any fund investor, promptly after the end of fundraising and annually thereafter. In addition, the adviser is required to provide written notice to an investor prior to its admission to the fund of all material, economic preferential treatment provided to other fund investors. The Adopting Release indicates that economic treatment includes economic terms relating to non-fund activities, such as co-investment rights or rights to invest in successor funds.

As a result of the rule, advisers will need to disclose to all fund investors any "side letters" or other preferential rights granted to any fund investor. However, the rule requires disclosure of preferential treatment, not only the granting of preferential treatment rights. Accordingly, any practice which treats fund investors differently should be scrutinized to determine whether such treatment should be disclosed to all fund investors.

Sharing Information

The preferential treatment rule prohibits the adviser from sharing information with a fund investor about portfolio investments if the adviser reasonably expects that it would have a material, negative effect on other investors, unless the adviser provides the information to all fund investors at the same time. In the Adopting Release, the SEC indicated that it takes a broad view of information that is covered by this rule, including information that allows a fund investor to make investments in competition with the fund.

Similar to the disclosure obligations, this rule prohibits preferential provision of information, not only the granting of preferential information rights. Accordingly, advisers should consider whether informal provision of information to a fund investor should instead be made through a formal process to all fund investors.

Redemption

The preferential treatment rule prohibits the adviser from granting a fund investor a preferential ability to redeem its interest in the fund if the adviser reasonably expects that redemption would have a material, negative effect on other investors, unless the redemption is required by applicable law or the redemption ability is offered, and will continue to be offered, to all fund investors.

Compliance Date and Legacy Funds

The date that an adviser's obligation to comply with the preferential treatment rule begins depends on the adviser's private fund assets under management. An adviser with less than $1.5 billion private fund assets under management must comply with the rule starting 18 months after formal publication, i.e., March 14, 2025. An adviser with $1.5 billion or more private fund assets under management must comply starting 12 months after formal publication, i.e., September 14, 2024.

Legacy funds are excluded from the prohibitions on preferential information sharing and redemption if the fund commenced operations before the compliance date, but only if the fund's governing agreements, entered into before the compliance date, would require amendment to comply with the rule. Legacy funds are not excluded if the adviser can comply without amendment to a fund's governing agreements; for example, if the governing agreements permit an adviser to share information with fund investors. In any event, legacy funds are not excluded from the obligation to disclose preferential treatment.

Restricted Activities Rule⁴

The new restricted activities rule prohibits private fund advisers from engaging in a variety of different activities relating to expenses, clawbacks, and borrowing. In some cases, the private fund adviser is permitted to engage in the activities with disclosure and/or consent of fund investors.

Regulatory/Compliance Expenses

If an adviser seeks reimbursement or charges a fund for the adviser's regulatory or compliance expenses, including an SEC examination, the adviser must provide fund investors with separate disclosure of those expenses, including the dollar amounts incurred, on a quarterly basis. Many funds' governing agreements permit charging a fund for regulatory and compliance expenses; advisers that continue this practice will need to separately track and disclose such expenses.

The restricted activities rule also prohibits an adviser from seeking reimbursement or charging a fund for expenses associated with an investigation of the adviser by the SEC or other government authorities unless a majority in interest of the fund investors consent. The rule does not specify whether blanket consent embodied in a fund's governing agreements would be sufficient or whether consent must be sought on a case-by-case basis. However, the Adopting Release does specify that consent by a fund's "LP advisory committee" is insufficient.

Regardless of whether fund investors consent, the restricted activities rule prohibits an adviser from seeking reimbursement or charging a fund for expenses associated with an investigation of the adviser by the SEC or other government authorities if the investigation results in a sanction for violation of the Advisers Act.

Multiple Fund Portfolio Expense Allocation

The restricted activities rule requires that if multiple private funds with the same adviser co-invest in the same portfolio investment, expenses associated with the investment generally must be allocated among the funds on a pro rata basis.

The restricted activities rule permits these expenses to be allocated on a non-pro rata basis so long as the allocation is "fair and equitable" and, prior to the non-pro rata allocation, the adviser discloses the allocation together with a description of the basis for the allocation. The rule does not require disclosure before a co-investment is consummated; the rule would permit disclosure after a co-investment is made but before expenses are charged.

The restricted activities rule does not restrict the allocation among multiple funds of expenses that benefit multiple funds but are not related to portfolio investments, such as shared fund organizational expenses.

Many funds' governing agreements permit a non-pro rata allocation of portfolio investment expenses among multiple funds in certain circumstances, such as different tax or regulatory needs of different funds' investors; if portfolio investment expenses are allocated in a non-pro rata manner, advisers to those funds will need to separately track and disclose such expenses, and determine that the non-pro rata allocation is fair and equitable.

Clawback Reduction for Taxes

Many fund agreements incorporate a "clawback" obligation that requires the fund's adviser or related persons to return performance-based compensation, such as carried interest, under certain circumstances. If a clawback occurs, and the amount returned is reduced by actual or deemed taxes of the fund's adviser or related persons, the restricted activities rule requires the fund adviser to provide notice to all fund investors of the reduction, including the dollar amount. The rule does not distinguish between a final clawback occurring at a fund's liquidation, and interim clawbacks occurring during the fund's term.

Many funds' governing agreements permit a reduction in clawback amounts for actual or deemed taxes; if a clawback occurs, those funds will need to separately disclose the reduction.

Adviser Borrowing

The restricted activities rule prohibits an adviser from borrowing money or other assets from a fund unless the material terms of the borrowing are disclosed to fund investors and a majority in interest of the fund investors consents to the borrowing.

Compliance Date and Legacy Funds

The date that an adviser's obligation to comply with the restricted activities rule begins depends on the adviser's private fund assets under management. An adviser with less than $1.5 billion private fund assets under management must comply with the rule starting 18 months after formal publication, i.e., March 14, 2025. An adviser with $1.5 billion or more private fund assets under management must comply starting 12 months after formal publication, i.e., September 14, 2024.

Legacy funds are excluded from the restrictions on borrowing and charging investigation expenses that do not lead to an Advisers Act sanction, if the fund commenced operations before the compliance date, but only if the fund's governing agreements, entered into before the compliance date, would require amendment to comply with the rule. Legacy funds are not excluded if the adviser can comply without amendment to a fund's governing agreements. Legacy funds are not excluded from the other restrictions in the rule.

New and Amended Rules for Registered Investment Advisers

Private fund advisers that are registered with the SEC under the Advisers Act must comply with new or amended rules relating to annual financial audits, quarterly statements, and adviser-led secondaries.

Annual Audit Rule⁵

The new annual audit rule requires registered investment advisers to provide annual audited financial statements to fund investors within 120 days of the end of the fund's fiscal year. The audit must be performed by a PCAOB-registered auditor and comply with generally accepted accounting principles.

The rule provides a limited exception for certain funds that an adviser advises but does not control. For such funds, the adviser must take "all reasonable steps" to have the fund provide annual audited financial statements to investors.

As a practical matter, the new annual audit rule is unlikely to affect most advisers to venture capital and private equity funds. Most registered investment advisers to venture capital and private equity funds already provide annual audited fund financial statements in order to comply with the existing Advisers Act custody rule.⁶

Compliance Date and Legacy Funds

Advisers must comply with the annual audit rule starting 18 months after formal publication, i.e., March 14, 2025. There are no exclusions from the rule for legacy funds.

Quarterly Statement Rule⁷

The new quarterly statement rule requires registered investment advisers to provide quarterly disclosures to fund investors. The rule does not require that advisers provide quarterly fund financial statements, but does require substantial fund disclosures, including but not limited to:⁸

• the list of fund portfolio investments;
• compensation and fees paid or allocated to the fund's adviser, including management fees, carried interest, and other performance-based compensation;
• fees and expenses paid by the fund, broken down into separate categories;
• fees paid to the adviser by fund portfolio companies;
• management fee offsets or rebates resulting from fees paid by fund portfolio companies;
• the fund's net and gross internal rate of return and multiple on invested capital on a whole-fund basis, as well as gross internal rate of return and multiple on investment capital separately on the realized and unrealized portions of the fund's portfolio; and
• contributions made to, and distributions made by, the fund.

Compensation and expenses must be cross-referenced to relevant provisions in the fund's governing agreements.

The quarterly statement must be provided within 45 days after the first three fiscal quarters of a fund's fiscal year, and within 90 days after the fourth fiscal quarter (or 75 and 120 days for a fund of funds).

Performance disclosures required by the quarterly statement rule are different than performance disclosures permitted by the recently enacted Advisers Act marketing rule.⁹ If the quarterly statements are provided to potential fund investors, those statements should be harmonized with the requirements of the marketing rule.

Compliance Date and Legacy Funds

Advisers must comply with the quarterly statement rule starting 18 months after formal publication, i.e., March 14, 2025. There are no exclusions from the rule for legacy funds.

Adviser-Led Secondaries Rule¹⁰

The new adviser-led secondaries rule imposes requirements for certain secondary transactions. The rule covers transactions initiated by a fund's adviser where fund investors are offered the choice between i) selling all or part of their interest in the fund, or ii) converting all or a portion of their interest in the fund to an interest in another vehicle under the same adviser, such as a continuation fund. The rule does not apply to transactions where a fund investor may choose to retain its ongoing interest in the fund. In many circumstances, a fund restructuring can be structured to permit an investor to retain its interest in a fund, rather than exchanging its fund interest for an interest in another vehicle.

If a fund's adviser proposes to engage in a transaction covered by the rule, the adviser must have an independent financial advisor deliver to fund investors either an opinion that the transaction is fair or an opinion as to the value of the assets being sold in the transaction. The adviser must also disclose all material business relationships with the independent financial advisor.

Compliance Date and Legacy Funds

The date that an adviser's obligation to comply with the adviser-led secondaries rule begins depends on the adviser's private fund assets under management. An adviser with less than $1.5 billion private fund assets under management must comply with the rule starting 18 months after formal publication, i.e., March 14, 2025. An adviser with $1.5 billion or more private fund assets under management must comply starting 12 months after formal publication, i.e., September 14, 2024. There are no exclusions from the rule for legacy funds.

Books and Records Rule¹¹/Compliance Procedures and Practices Rule¹²

The existing books and records rule is amended to require registered investment advisers to keep written records of disclosures, notices, and statements required by the new and amended rules. In addition, the existing compliance procedures and practices rule is amended to clarify that registered investment advisers' annual review of compliance policies and procedures must be documented in writing.

Application to Non-U.S. Advisers

The new rules do not expressly exclude non-U.S. advisers. However, in the Adopting Release, the SEC clarified that the new rules do not apply to an adviser that has its principal office outside the United States to the extent that it advises funds formed outside the United States, even if the funds have U.S. investors. However, a non-U.S. adviser is required to comply with the new rules to the extent it advises funds formed in the United States.

Legal Challenge to the Rules

On September 1, 2023, the National Venture Capital Association, the National Association of Private Fund Managers, the Managed Funds Association, and other asset management associations filed a lawsuit against the SEC seeking to set aside the rules adopted by the Adopting Release.¹³ The filing of the lawsuit does not automatically pause or delay compliance obligations under the rules. However, the plaintiffs may seek to delay compliance obligations while litigation is pending.

Further Information

If you have any questions about the new Advisers Act rules, please contact Brian M. McDaniel, Amy B. Caiazza, or another member of Wilson Sonsini’s fund formation or fintech practices.

---

[1] Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews, Investment Advisers Act Release No. 6383 (Aug. 23, 2023) (the "Adopting Release").

[2] The rules also impose obligations on advisers to hedge funds and other funds which offer investors the ability to redeem their interests. Obligations of such advisers are not discussed in this alert.

[3] Advisers Act Rule 211(h)(2)-3.

[4] Advisers Act Rule 211(h)(2)-1.

[5] Advisers Act Rule 211(h)(1)-2.

[6] Advisers Act Rule 206(4)-2.

[7] Advisers Act Rule 211(h)(1)-2.

[8] As noted above, this alert focuses on obligations of advisers to venture capital and private equity funds. Different disclosure rules apply to advisers to hedge funds and other funds.

[9] Advisers Act Rule 206(4)-1.

[10] Advisers Act Rule 211(h)(1)-2.

[11] Advisers Act Rule 204-2.

[12] Advisers Act Rule 206(4)-7.

[13] See https://nvca.org/wp-content/uploads/2023/09/001-1-Petition-for-Review.pdf.