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New SEC rules pertinent to investment advisers

24 Mar 2023 | 5 minute read

By Richard Casciani, Director, U.S.

The U.S. Securities and Exchange Commission (SEC) updates its regulatory agenda twice each year, and the most recent “Reg Flex” agenda shows the SEC likely will finalize two dozen rules by the end of 2023.

Among the proposed rules, three areas are of particular importance to the advisory community:

  • ESG disclosures for investment advisers and funds: Funds that integrate environmental, social and governance (ESG) strategies would be required to provide additional disclosures in fund materials. In some cases, funds looking to achieve certain ESG impacts would be required to disclose metrics for assessing progress toward those goals
  • Enhanced regulation of private fund advisers: Private fund advisers registered with the SEC would be required to distribute quarterly statements to investors that include detailed accounting of fees and expenses, as well as company ownership and performance information. The rule also would establish various conditions to protect private fund investors
  • Cybersecurity risk management: Advisers and funds would need to create firm policies surrounding several critical cybersecurity functions, regularly review those policies and report “significant” incidents to the SEC

In this article, we provide a clear overview of the key points in each of these proposals.

ESG disclosures for investment advisers and funds

The proposed amendments to rules and disclosure forms aim to promote consistent, comparable and reliable information for investors concerning funds’ and advisers’ incorporation of ESG factors. Disclosures would be enhanced by requiring:

  • Additional specific disclosures regarding ESG strategies in fund prospectuses/memoranda, annual reports and adviser brochures
  • Implementation of a layered, tabular disclosure approach for ESG funds to allow investors to compare such funds at a glance
  • Certain environmentally focused funds to disclose the greenhouse gas (GHG) emissions associated with their portfolio investments

The proposal identifies three types of ESG fund, each of which has different levels of requirement:

Integration funds

Funds that integrate ESG factors alongside non-ESG factors in investment decisions.

These funds would be required to describe how ESG factors are incorporated into their investment processes.

ESG-focused funds

Funds for which ESG factors are a significant or main consideration.

These funds would be required to provide detailed disclosure, including a standardized ESG strategy overview table.

Impact funds

A subset of ESG-Focused Funds that seek to achieve a particular ESG impact.

Beyond the requirements of ESG-Focused Funds, these funds would be required to provide additional information on the impact(s) they seek to achieve and the key metrics being used to measure progress.

Additional disclosure requirements:

  • Proxy voting or engagements: Funds that use proxy voting or engagement with issuers as a significant means of implementing their ESG strategy would need to provide further information about their proxy voting or ESG engagements, as applicable
  • GHG emissions reporting:
    • ESG-Focused Funds that consider environmental factors in their investment strategies would need to disclose additional information regarding the GHG emissions associated with their investments, i.e. carbon footprint and the weighted average carbon intensity of the portfolio
    • Integration Funds that consider GHG emissions would be required to disclose additional information about how the fund considers GHG emissions, including the methodology and data sources the fund may use as part of this consideration

For more information, click here to read the SEC Factsheet.

Enhanced regulation of private fund advisers

New rules and amendments are proposed under the Investment Advisers Act of 1940 to enhance the regulation of private fund advisers. The proposal includes five new rules, as follows:

Quarterly Statement Rule

The Quarterly Statement Rule requires all SEC-registered private fund advisers to provide investors with quarterly statements detailing information about private fund performance, fees and expenses. The statement would include, in table format at both fund and portfolio level:

  • Detailed accounting of all fees and expenses paid to the private fund adviser and/or its related persons, including any management fee offsets
  • Any other fees and expenses that portfolio investments pay to the private fund adviser and its related persons
  • Certain portfolio company ownership and performance information

Private Fund Audit Rule

The Private Fund Audit Rule requires registered private fund advisers to obtain an annual audit for each private fund they advise and cause the private fund’s auditor to notify the SEC upon certain events

Adviser-Led Secondaries Rule

The Adviser-Led Secondaries Rule requires registered private fund advisers, in connection with an adviser-led secondary transaction, to distribute to investors a fairness opinion (on the price offered by the adviser) from an independent opinion provider, supported by a written summary of any material business relationships held between the adviser and the opinion provider or its related persons over the past two years

Prohibited Activities Rule

The Prohibited Activities Rule prohibits all private fund advisers (including unregistered advisers) from engaging in certain activities and practices that are contrary to public interest and the protection of investors, including:

  • Seeking reimbursement, indemnification, exculpation or limited liability for a breach of fiduciary duty, willful misfeasance, bad faith, negligence or recklessness in providing services to the private fund
  • Charging certain fees and expenses related to a portfolio investment on a non-pro rata basis when multiple private funds or other clients advised by the private fund adviser have invested or propose to invest in the same
  • Charging fees for unperformed services, e.g. accelerated monitoring, servicing, consulting or other fees that the adviser has yet to perform and/or does not reasonably expect to perform for the portfolio investment
  • Reducing clawback amounts by taxes, i.e. providing for a clawback of carried interest net of taxes, whether net of actual taxes or of a set rate of tax
  • Borrowing any assets or otherwise seeking an extension of credit from a private fund client
  • Charging private funds for fees and expenses associated with the regulatory and compliance activities of the adviser or its related persons (as opposed to those activities of the fund itself, which would be permissible to recharge), including expenses incurred in connection with examinations or investigations by a regulatory or governmental authority

Preferential Treatment Rule

The Preferential Treatment Rule prohibits all private fund advisers from providing preferential terms to certain investors that have a material negative effect on other investors, while also conditioning other types of preferential treatment on disclosure to current and prospective investors. The following side agreements between advisers and investors would be strictly prohibited:

  • Granting of preferential liquidity terms
  • Provision of information regarding the private fund’s portfolio holdings or exposures (if the adviser reasonably expects that such preferential treatment would have a material, negative effect on other investors in the fund)
  • Provision of any other kind of preferential treatment without also providing:
    • Written notice to each prospective investor that includes specific disclosure regarding any preferential treatment
    • Annual written notice to current investors in an ongoing offering that includes specific disclosure regarding any preferential treatment provided by the private fund adviser to other investors in the private fund

As well as the five new rules, the SEC are also proposing amendments to the existing Books and Records Rule, requiring advisers to retain records in relation to the new rules, and the Compliance Rule, requiring all registered advisers (including those that do not advise private funds) to document their annual review in writing.

For more information, click here to read the SEC Factsheet.

Cybersecurity risk management

New cybersecurity risk management rules and related amendments to certain rules are proposed under the Investment Advisers Act of 1940 and the Investment Company Act of 1940, with the goal of enhancing cybersecurity preparedness and improving the resilience of investment advisers and funds against cybersecurity threats and attacks.

The proposed changes include adoption and implementation of written policies and procedures, and increased reporting, disclosures and record-keeping.

For more information on this proposal, read our dedicated article on the 10 key elements of the SEC’s proposed cybersecurity rules.

You can also click here to read the SEC Factsheet.

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