New Rules Create New Challenges for Investment Advisers

Back in August 2023, the SEC adopted several new rules that require increased transparency, and in some cases, prohibition, of preferential treatment of investors. As a result, private fund advisers now need to review their funds’ agreements related to investors to identify preferential treatment.

The agreements that should be reviewed include investor side letters, subscription agreements, limited partnership agreements, limited liability company agreements, and articles of association or bylaws. Until now it has been common practice to use these agreements to grant more favorable rights and privileges to certain investors such as:

• early, seed or strategic investors, large size investors, employees, friends and family; or
• investors subject to government regulation (e.g., ERISA, BHCA, State pension systems).

What You Should Know About the Preferential Treatment Rule

Under the new Preferential Treatment rule, three key requirements stand out:

1. Advisers are prohibited from granting preferential redemption or information rights about portfolio holdings that would have a material, negative effect on other investors in the private fund or a similar pool of assets. Fortunately, there is some exemption for legacy agreements that were entered into prior to the compliance date.
   
   
2. Advisers are required to provide advance written notice to prospective investors of preferential treatment related to any material economic terms (such as cost of investing, liquidity rights, fee breaks and co-investment rights). An adviser could comply with this requirement by providing a summary of the preferential terms (or copies of side letters and other agreements (with the identity of other investors redacted).
   
   
3. Advisers are required to provide timely after-the-fact and annual written notices to current investors of all preferential treatment.

When Will These Changes Take Effect?

These SEC rules will apply to advisers managing $1.5B or more beginning September 14, 2024 and to advisers managing less than $1.5B beginning March 14, 2025. 

How Contract Review Software Can Help Private Fund Advisers with Compliance

To comply with these rules advisers are going to have to review their existing documents to identify provisions that grant preferential treatment.

Then they must work out whether these provisions:

(i) would be prohibited from being agreed to going forward;

(ii) would need to be disclosed to prospective investors;

(iii) would, when agreed to, need to be disclosed to current investors and then annually thereafter.  

Undertaking this review can certainly seem daunting if you have hundreds of documents to review at once.  If approached manually, it would take a long time and tie up internal resources and/or require expensive external resources to help. That's where a contract review software solution like Catylex can be a game changer. Catylex leverages AI technology to assess agreement provisions swiftly and accurately. We can help you save valuable time and resources and deliver results in a fraction of the time and at a significantly reduced cost compared to the traditional manual review process.