The SEC’s New Private Funds Rules on Preferential Treatment: How Do They Compare With the AIFMD? | Goodwin
The US Securities and Exchange Commission (SEC) recently adopted new rules for private fund managers, which we covered in our alert SEC Adopts Expansive (Albeit Slightly Softened) Private Funds Rules.
The new rules include restrictions on preferential treatment of investors, which the EU Alternative Investment Fund Managers Directive (AIFMD) also addresses. Noting that there are various instances that could bring an EU AIFM within the scope of the new SEC rules, we examine how the new obligations under the SEC rules compare with those that AIFMs are subject to under EU member state laws (and UK law and regulation) implementing the AIFMD.
Some Context
Side letters and most-favored-nations (MFN) provisions allow fund houses to incentivise early, large, or strategic commitments, and give investors the ability to negotiate bespoke terms. Common side letter provisions include fee breaks, limited partner advisory committee (LPAC) seats, reporting requirements, ESG, tax or regulatory provisions, and excuse and transfer rights.
The MFN process typically involves the manager disclosing all side letter terms to investors after final close, following which each investor can take advantage of terms agreed with other investors — in many cases, based on having committed the same amount as, or more than, that investor (subject to some exceptions). Regulatory overlay is aimed at ensuring transparency and fairness.
When the SEC Rules Might Apply to an AIFM
Non-US advisers will typically be exempt from the new SEC private funds rules with respect to their non-US funds, including the restrictions on preferential treatment of investors (whether or not the non-US funds have US investors and/or make US investments). That said, there are various instances that could bring a non-US adviser within the new rules — for example, where a fund structure includes a Delaware feeder or parallel vehicle or has a US sub-adviser, where the non-US adviser is a “relying adviser” of an affiliated US adviser, or where a manager or adviser is a joint venture (JV) with a US adviser (unless there is sufficient independence between the JV manager/adviser and the US adviser).
These firms are therefore likely to be subject to both the AIFMD’s provisions on the fair treatment of investors and the SEC’s new private funds rules on preferential treatment. Whether or not a non-US adviser has to comply with respect to a particular fund, we expect that managers will still want to monitor the new SEC regulatory approach and consequent impact on investor expectations, disclosure and reporting practices, and market developments in general — and thus the shape of their policies and best practices.
Disclosures for Preferential Treatment in General
Restrictions on Preferential Redemption and Information Rights
Annual Notice Requirement
Practical Action Points
Managers/GPs subject to the new SEC rules will want to identify on a fund-by-fund basis any preferential redemption and information rights that would need to be offered to all investors in future fundraisings, along with any other material economic terms that would need to be disclosed to all investors before they subscribe. They will also want to review side letter disclosure practices to ensure that preferential terms are disclosed in time and that annual updates are provided for any additional rights granted. SEC grandfathering provisions may help, as preexisting funds whose governing documents were entered into before the compliance date and that under the new rule would require amendment (e.g. to be able to offer redemption rights to all investors where this was previously restricted in the fund documents) would be exempt from the restrictions on preferential treatment with respect to redemption and information rights. No such legacy status is being applied to the new disclosure and notice requirements detailed above. Therefore, commencing on the compliance date (likely to be in 2025), all private fund advisers subject to the new SEC rules will need to start making the required disclosures and notices of all preferential treatment with respect to all existing funds.
We continue to watch how market practice evolves in this area, including tracking the developments in the lawsuit filed by the Managed Funds Association and others on 1 September challenging the SEC’s power in this area. The suit states that the adoption of the new private funds rules exceeds the SEC’s statutory authority, fails to address the stated objectives, and will harm institutional investors and their beneficiaries.
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