The SEC has brought new regulations into the asset wealth management industry aimed at protecting investors who directly or indirectly invest in private funds designed to prevent fraud, deception, or manipulation by the investment advisers to those funds.
Private funds are privately offered investment vehicles that pool capital from one or more investors and invest in securities and other instruments or investments. They’re generally advised by investment advisers subject to federal fiduciary duty, the antifraud, and other provisions of the Investment Advisers Act of 1940 (the “Advisers Act”).
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“the Dodd-Frank Act”) strengthened the Commission’s role in overseeing private funds under the previously existing antifraud provisions of section 206 (“the Custody Rule”).
Originally adopted in 1962 and amended in 2009 via the Dodd-Frank Act, the Custody Rule required investment advisers to safeguard their client’s funds and securities against financial reverses the advisers may experience (i.e., insolvency) as well as against loss, misuse, theft, and misappropriation.
Chief among the various provisions of the rule was the requirement of advisers with custody of client assets to arrange by written agreement for an independent public accountant to verify assets by way of annual surprise examination and follow specific enumerated procedures.
Citing over a decade of extensive experience in overseeing and regulating private funds, the Commission has observed three primary factors that contribute to investor protection and harms, which has now prompted further regulatory changes:
The new regulatory changes to the Advisers Act introduce several new rules that SEC-registered advisers must comply with.
Most notable is the Audit Rule, which will now require that an SEC-registered adviser have each private fund it advises undergo an annual audit consistent with the “limited partnership subject to annual audit” provision under 17 CFR 275.206(4)-2.
Opponents of this rule change commented that it would eliminate the surprise examination option under the Custody Rule without evidence that surprise examinations have not adequately protected private fund investors.
Furthermore, opponents argued that the new Audit Rule may:
While the mandatory private fund adviser Audit Rule would effectively eliminate the surprise examination option under the Custody Rule for private fund advisers and may increase costs to some investors, the Commission believes that financial statement audits provide a critical set of additional protections for private fund investors.
Overall, audits enhance investor protection, and the mandatory private fund adviser Audit Rule would introduce a degree of consistency across private funds.
The Private Fund Advisers rule, as adopted by the SEC, went into effect on November 13, 2023, and SEC-registered advisers have 18 months to comply with the new regulations.
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