If you’re in the U.S. investment industry in any capacity, you’ve likely been reading up on the latest SEC ruling that imposes stricter regulations on private fund advisers. The SEC’s Private Fund Adviser rule (the “Rule”) is a set of regulations that govern the activities of investment advisers who advise private funds. The SEC Private Funds Rule was officially adopted by the SEC on August 23, 2023, and it will go into effect on March 23, 2024 with “staggered compliance transition dates depending on the type of rule and the level of an adviser’s private fund assets under management,” according to White & Case LLP.
The Rule applies to all investment advisers that advise private funds, regardless of whether they are registered with the SEC. The Rule includes five main provisions:
- The Restricted Activities Rule prohibits investment advisers from engaging in certain activities that could harm investors, such as charging excessive fees, self-dealing, and conflicts of interest.
- The Preferential Treatment Rule prohibits investment advisers from providing preferential treatment to certain investors, such as giving them early access to information or allowing them to redeem their investments more easily than other investors.
- The Quarterly Statement Rule requires investment advisers to provide quarterly statements to their investors that disclose certain information about the private fund, such as its financial performance and valuation.
- The Audit Rule requires investment advisers to obtain an annual audit of each private fund they advise.
- The Adviser-Led Secondary Rule requires investment advisers to obtain a fairness opinion or valuation opinion before engaging in an adviser-led secondary transaction, such as a sale of interests in a private fund to new investors.
1. The “Why” Behind the SEC Private Funds Rule
The Private Funds Rule is designed to protect investors in private funds by increasing the transparency and accountability of investment advisers. The Rule is also expected to level the playing field for investors by reducing the opportunities for investment advisers to give preferential treatment to certain investors. The SEC specifically noted a current lack of transparency, conflicts of interest between advisers and investors, and poor governance mechanisms built into a typical private fund structure to protect the interests of the investors.
The Rule has been met with mixed reactions from the investment management industry. Some industry participants have welcomed the Rule, arguing that it is necessary to protect investors and level the playing field. Other industry participants have criticized the Rule, arguing that it is too burdensome and will increase the cost of doing business for investment advisers.
Only time will tell how the Rule will impact the investment management industry. However, it is clear that the Rule is a significant development in the regulation of private funds.
2. Stricter Requirements for Quarterly Reporting
While the provisions listed above may seem pretty clear-cut and self-explanatory, there are a few we wanted to draw additional attention to that may impact commercial real estate GPs more than others. One of those provisions is the quarterly statement provision.
As a GP, you may already provide quarterly statements or reports of some kind to your investors. However, the requirements listed in the new Private Funds Rule are more stringent than what you may typically include. We’ve summarized the requirements below:
- Fund’s financial performance: This includes information such as the fund’s net asset value (NAV), returns, and expenses.
- Valuation of the fund’s investments: This includes information about how the fund’s investments are valued and how the valuation process is conducted.
- Fees and expenses: This includes information about the fees and expenses that are being charged to the fund and how they are calculated.
- Transactions: This includes information about the fund’s trading activity, such as the number and value of securities purchased and sold.
- Distributions: This includes information about the fund’s distributions to investors, such as the amount and timing of the distributions.
- Other information: This includes information that is relevant to the fund’s operations, such as changes in the fund’s investment strategy or changes in the fund’s management team.
The quarterly statement must be distributed to investors within 60 days of the end of the quarter. For example, if the quarter ends on March 31, the quarterly statement must be distributed to investors by May 31.
Here are some additional things to keep in mind about the quarterly statement:
- The statement must be in writing and must be delivered to investors in a way that they can reasonably be expected to receive it.
- The statement must be accurate and complete.
- The statement must be prepared in accordance with the SEC’s rules and regulations.
If you are a general partner who manages a private fund, it is important to understand the requirements of the quarterly statement rule and to ensure that you are complying with these requirements. By doing so, you can help to ensure that your fund is transparent and accountable to its investors.
3. Annual Compliance Audits Now Required
Another key provision that may change the way GPs conduct business is the requirement for an annual audit. The audit rule requires investment advisers to obtain an annual audit of each private fund they advise. The audit must be conducted by an independent public accountant who is registered with, and subject to regular inspection by, the Public Company Accounting Oversight Board (PCAOB).
The audit must cover the fund’s financial statements for the most recent fiscal year and must be conducted in accordance with generally accepted accounting principles (GAAP). The auditor must also issue an opinion on the fund’s financial statements, stating whether they are presented fairly, in all material respects, in accordance with GAAP.
The audit rule is designed to help ensure that the financial statements of private funds are accurate and reliable. The audit also helps to protect investors by providing them with an independent assessment of the fund’s financial condition.
Here are some additional things to keep in mind about the audit rule:
- The audit must be completed within 120 days of the end of the fund’s fiscal year.
- The auditor must be selected by the fund’s board of directors or by a committee of the board.
- The auditor must be independent of the fund and its management.
- The auditor must report any material findings to the fund’s board of directors.
If you are a general partner who manages a private fund, it is important to understand the requirements of the audit rule and to ensure that you are complying with these requirements. By doing so, you can help to ensure that your fund’s financial statements are accurate and reliable and that your investors are protected.
4. Penalties for SEC Private Funds Rule Non-Compliance
If a private funds adviser is found to be non-compliant with the SEC’s Private Fund Adviser rule, the SEC can take a number of enforcement actions, including:
- Cease-and-desist order: The SEC can issue a cease-and-desist order that prohibits the adviser from engaging in the non-compliant activity.
- Injunction: The SEC can file an injunction in court that prohibits the adviser from engaging in the non-compliant activity.
- Civil penalties: The SEC can impose civil penalties on the adviser, up to $500,000 per violation.
- Criminal prosecution: The SEC can refer the matter to the Department of Justice for criminal prosecution.
In addition to the enforcement actions that the SEC can take, a private funds adviser who is found to be non-compliant may also face other consequences, such as:
- Damages: Investors who have been harmed by the adviser’s non-compliance may be able to sue the adviser for damages.
- Reputational damage: The adviser’s reputation may be damaged, which could make it difficult to attract new investors.
- Loss of business: The adviser may lose business from existing investors.
The specific consequences that a private funds adviser faces will depend on the specific facts and circumstances of the case. However, it is important for private funds advisers to be aware of the potential consequences of non-compliance with the SEC’s Private Fund Adviser rule.
Here are some tips for private funds advisers to stay compliant with the SEC’s Private Fund Adviser rule:
- Get familiar with the rule: The first step is to get familiar with the rule. The SEC has a number of resources available to help advisers understand the rule, including the rule itself, FAQs, and enforcement actions.
- Implement compliance procedures: Once you understand the rule, you need to implement compliance procedures to ensure that you are in compliance. These procedures should be tailored to your specific business and should be regularly reviewed and updated.
- Get help from a lawyer: If you are unsure about how to comply with the rule, you should get help from a lawyer who is experienced in securities law. A lawyer can help you develop and implement compliance procedures and can advise you on any potential risks.
By following these tips, private funds advisers can help to ensure that they are in compliance with the SEC’s Private Fund Adviser rule and protect themselves from the consequences of non-compliance.
5. The SEC Private Funds Rule’s Impact on Commercial Real Estate
The projected impact of the new SEC regulation on commercial real estate funds specifically is still being debated, but it is likely to have a significant impact on the industry. Some of the potential impacts include:
- Increased transparency: The new regulations will require commercial real estate funds to provide more information to investors, such as their financial performance, valuation, and investment strategies. This will make it easier for investors to make informed decisions about whether to invest in a particular fund.
- Enhanced due diligence: The new regulations will also require investors to conduct more due diligence on commercial real estate funds before investing. This will help to ensure that investors are aware of the risks associated with investing in these funds.
- Increased costs: The new regulations will likely increase the costs of managing commercial real estate funds. This is because funds will need to invest in new systems and procedures, like investment management platforms with integrated reporting and security features, to comply with the regulations.
- Reduced liquidity: Some industry experts predict that the new regulations may reduce the liquidity of commercial real estate funds. This is because investors may be less willing to invest in funds that are subject to more stringent regulations.
- Shift in investment strategies: The new regulations may also lead to a shift in investment strategies for commercial real estate funds. Funds may be more likely to invest in assets with less risk and more liquidity in order to comply with the regulations.
In addition to the impacts mentioned above, the new SEC regulation could also have the following effects on commercial real estate funds:
- Increased scrutiny from regulators: The new regulations will likely increase the scrutiny that regulators, such as the SEC, give to commercial real estate funds. This could lead to more enforcement actions against funds that violate the regulations.
- Increased competition: The new regulations could also lead to increased competition among commercial real estate funds. This is because funds will need to find ways to reduce their costs and improve their performance in order to compete with other funds that are also subject to the regulations.
- Changes in the industry landscape: The new regulations could also lead to changes in the industry landscape. Some funds may merge or be acquired by other funds in order to comply with the regulations. Other funds may exit the market altogether.
The full impact of the new SEC regulation on the commercial real estate fund industry is still unknown. However, it is clear that the regulations will have a significant impact on the industry. Using a secure investment management platform like Covercy can help General Partners who manage commercial real estate funds stay compliant with the SEC’s Private Funds rule. Here are some of the ways that a secure investment management platform can help:
- Increased transparency: A secure investment management platform can help to increase transparency by providing a central location for storing and managing all of the fund’s information, such as financial statements, investor agreements, and trading records. This can help to make it easier for investors to track the fund’s performance and to identify any potential conflicts of interest.
- Enhanced security: A secure investment management platform can help to enhance security by providing features such as role-based access control, encryption, and audit trails. This can help to protect the fund’s information from unauthorized access, alteration, or destruction.
- Automated compliance: A secure investment management platform can help automate compliance by providing features such as workflow management and alerts. This can help to ensure that the fund is complying with all of the relevant regulations, such as the quarterly statement rule and the audit rule.
- Reduced costs: A secure investment management platform can help to reduce costs by streamlining the investment management process. This can be achieved by automating tasks such as data entry, reporting, and compliance.
Manage SEC Compliance with a Secure Investor Management Platform
Even without the latest SEC ruling, using a secure investor management platform like Covercy is a smart decision for General Partners who manage real estate funds. By providing investors with an always-available investor portal, enhanced security, automated compliance, and reduced costs via a more efficient business workflow, Covercy can help General Partners stay compliant with the SEC’s Private Fund Adviser rule and protect the interests of their investors.
In addition to the features mentioned above, Covercy offers a few unique differentiators when compared to popular real estate investment management platforms on the market:
- Embedded cash accounts: Covercy is the first investment management platform on the market with embedded checking accounts. By partnering with third-party banking institutions, Covercy offers General Partners and their investors the ability to open secure checking accounts right within the platform. Uncalled capital can be held in high-interest-earning accounts with no loss to liquidity, and General Partners can distribute earnings to investors with the click of a button. Similarly, investors can contribute capital directly to a fund with no fees or delays, all via ACH debit.
- “Invest Now” with Deal Marketing Pages: The “Invest Now” deal pages feature within Covercy streamlines the investment process and makes it more accessible for accredited investors, providing a convenient way to invest in commercial real estate deals & funds. By reducing friction in the investment process, it encourages more investors to make commitments and helps real estate firms raise capital more efficiently, with automated tracking and reporting built in.
- First Three Assets Free Forever: Covercy offers commercial real estate GPs a starter option to test out the platform while staying compliant, even with only a few assets to track. Alternatively, the Pro tier — which is tailored for larger teams and the management of commercial real estate funds — is available to try for free for up to 14 days before making a final decision on which Covercy tier is right for you.
Overall, Covercy is a highly valuable tool for General Partners who manage real estate funds. By providing a variety of features that can help general partners increase transparency, enhance security, automate compliance, reduce costs, manage investor relationships, make investment decisions, and track performance, a secure investment management platform can help general partners stay compliant with the SEC’s Private Fund Adviser rule and to protect the interests of their investors.