In this whitepaper, Houlihan Capital discusses the SEC's new rules for private fund advisers under the Investment Advisers Act of 1940 and changes that create major compliance obligations involving the valuation of fund investments.
On August 23, 2023, the Securities and Exchange Commission ("SEC") adopted sweeping reforms under the Investment Advisers Act of 1940 (“Advisers Act”) to enhance the regulation of private fund advisers. Private fund advisers registered with the Commission should read the new rules and amendments in full, available HERE. The changes create major compliance obligations involving the valuation of fund investments. Houlihan Capital is helping its clients minimize the costs, risks, and operational complexities of satisfying these obligations – namely, the regulatory requirements of the following three (3) rules:
Quarterly Statement Rule - This rule requires registered private fund advisers to provide quarterly statements to investors that disclose fund-level information on performance, cost of investing in the fund, fees, and expenses. Regarding fund performance, the rule requires advisers to illiquid funds to disclose a gross internal rate of return and gross multiple of invested capital for the realized and unrealized portions of each such fund’s portfolio. Determining the value of the unrealized portion of an illiquid fund’s portfolio can be technically challenging, sometimes necessitating reliance on sophisticated models and multiple unobservable inputs. Most private fund advisers are either ill-equipped to consistently perform valuations of illiquid investments or simply find the recurring exercise a distraction from core functions. Of course, the SEC is quick to point out advisers’ conflict of interest here, being they are typically evaluated and, in many cases, compensated based on unrealized performance. Outsourcing the appraisal of hard-to-value investments to an independent third-party expert such as Houlihan Capital addresses all these concerns, ensuring valuations are performed with professional competency and precluding the possibility that the SEC views the adviser’s valuation practices as deceptive.
Audit Rule – This rule requires private funds advised by registered fund advisers to undergo a financial statement audit that meets the requirements of the audit provision in the Advisers Act custody rule (rule 206(4-2)). In addition to providing protection for the fund and its investors against the misappropriation of fund assets, an audit by an independent public accountant provides an important check on the adviser’s valuation of private fund assets. Part of the audit process is evaluating the selection and application of valuation methods, including the significant assumptions and data used within those methods. Experienced private fund advisers know the pain of this aspect of audit, wherein it may be unclear how exactly to appease the audit partner (often as a valuation specialist communicates coded guidance or questions), leading to delays and cost overruns. By hiring from audit firms and constantly working with auditors to provide objective, independent and defensible opinions of value that meet all accounting and regulatory requirements, Houlihan Capital’s work product has been refined to be exceptionally clear, concise, and complete in preempting issues that could be raised in audit review. To the extent questions are still received on our recommended fair value measurements, our experts can draw on vast institutional knowledge gained from years of answering similar questions over thousands of projects, including repositories of verbatim audit Q&A.
Adviser-led Secondary Transactions Rule – This rule requires an adviser to obtain a fairness opinion or valuation opinion in connection with adviser-led secondary transactions, whereby the adviser offers fund investors the option to sell their interests in the private fund or to exchange them for new interests in another vehicle advised by the adviser. Further, it is necessary for the adviser to engage an “independent opinion provider” to this purpose, which means “a person that provides fairness opinions or valuation opinions in the ordinary course of its business and is not a related person of the adviser.” In other words, it is necessary to hire an entity such as Houlihan Capital. Our engagements are designed to reduce the risk of providing biased opinions, and our professionals have the experience in valuing most types of illiquid investments, even esoteric ones. Houlihan Capital is a premier provider of, and thought leader on, fairness opinions, including for adviser-led secondary transactions. See www.fairnessopinion.com for more information.
Houlihan Capital is a leading valuation, financial advisory and investment banking firm committed to delivering superior service to our clients. We have a proven track record as a trusted valuation provider to some of the largest and most reputable asset managers,’40 Act funds, private equity funds, hedge fund advisors, venture capital firms, and fund administrators around the world. Houlihan Capital is SOC-compliant, a Financial Industry Regulatory Authority (FINRA) and SIPC member, and committed to the highest levels of professional ethics and standards.
For questions regarding the SEC’s newly adopted rules, or to discuss valuation please contact: