Demystifying the New Rules for Private Fund Advisors
By: Andrew Huss and Jon Haidet
Last week the SEC released sweeping new rules for Private Fund Advisers. The industry is currently evaluating the rules and the detailed analysis contained within the SEC’s 660-page final rule and will have better clarity on next steps and needed actions in the weeks ahead.
During a first read of the final rule released, my attention was drawn to the numerous settled actions the SEC referenced to support “problematic practices” the need for further Commission oversight. A number of these problematic practices related to the miscalculation of fees, management fee offsets being inaccurately applied or not applied at all, and incorrect or disproportionate allocations of expenses to private fund clients.
While the new Quarterly Statement Rule should provide better transparency into fee calculations to investors in private funds and the new Audit Rule will require that each private fund advised by a SEC-registered adviser undergo an annual audit, advisers should ask themselves what actions they can take to self-identify problematic practices they may be unintentionally committing.
The simple answer to a number of these problems is to understand and follow the governing documents, primarily the Limited Partnership Agreements (“LPAs”) of each private fund they advise. Unfortunately, in practice it is not always that simple.
Having been in the private equity arena for 15+ years and having worked both in-house and as a third-party administrator, I have had the opportunity to see numerous LPAs and fund structures, ranging from simple to complex. I have seen governing documents that are extremely professionally written with clear concepts and free from methodology breaks and other governing documents that are riddled with inconsistencies and contain concepts that may not align with a manager’s intent.
If you are an adviser to a private fund with a simple, well-written LPA, you have less to worry about. On the other hand, if your document includes fee caps, offsets, and unique allocation rules, these need to be shown and discussed with your accounting and compliance teams from the beginning and routinely revisited.
How we can help We strongly recommend bringing a third-party fund administrator into the picture before documents are inked so the administrator can review a fund’s LPA and ask questions about how the fund is intended to administratively operate before the fund launches. A good administrator should be able to gain a clear understanding of what it will take to administer the fund throughout its lifecycle and should help private fund advisers confirm the document aligns with how they intended the fund to operate. Here at CLA, we jump at the opportunity to get involved with our private fund clients before their LPAs are final as we have repeatedly been able to help our clients start off on the right foot and in the right direction.
Craig Arends is a principal at CLA and is the managing principal of CLA's private equity practice. Craig brings a concentration of experience in providing accounting and transaction structuring advice for leveraged recapitalizations, purchase accounting and SEC reporting, assessing quality of earnings, and GAAP accounting. He has far-reaching experience with critiquing financial models and reviewing target companies' financial performance to identify cost reductions and/or operating efficiencies Craig has more than 30 years of experience in public accounting serving public companies, private equity groups, and companies, including a term as principal in charge of a Big Four Capital Markets Group in Moscow, Russia. He has led financial accounting due diligence projects for private equity investor groups and venture capital funds, primarily in the technology, communications, and manufacturing industries, as well as assisting with Foreign Corrupt Practice Act matters ranging from investigation of payments made, validation of compliance with corporate policies, and review of proposed transactions to ensure compliance. When not working, Craig enjoys watching any sports, but his most favorite are baseball, football and soccer.
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