Ghost of Private Fund Adviser Rules Haunts Recent Enforcement Action

After the Private Fund Adviser Rules were vacated in June, we cautioned advisers not to let their guard down on the topics covered by the rules, and a new enforcement action announced this week shows us why.

You may recall that the so-called “Preferential Treatment Rule” would have imposed significant limitations on an adviser’s ability to offer preferential liquidity to certain investors without offering the same terms to all investors. Well, the Preferential Treatment Rule is dead, but the SEC’s skepticism of offering preferential redemption rights lives on.

According to the SEC’s order in this case, the Limited Partnership Agreement (LPA) for a fund managed by the adviser required investors to provide 30 days’ written notice to redeem from the fund unless the fund’s General Partner (which was controlled by the adviser) approved a shorter notice period. The order states that, in practice, the adviser would generally permit investors to redeem with at least five days’ notice. However, the SEC notes that, while this practice was communicated to certain investors, it was not communicated to all investors and, further, that the adviser allowed certain investors, including investors affiliated with the adviser, to redeem with fewer than five days’ notice. Therefore, the SEC found that the adviser violated the antifraud provisions of the Advisers’ Act because it offered certain investors more favorable redemption terms than what had been disclosed to other investors.

As we said in our prior post, the Private Fund Adviser Rules being vacated was certainly a setback for the SEC, but the agency has other avenues to pursue enforcement actions against advisers related to the types of conduct covered by the rules, as this case evidences.

Bonus Takeaway!

Apart from the preferential liquidity issue noted above, this case also wades into the murky waters of crypto regulation. Specifically, the SEC alleges that the adviser invested in certain crypto assets “that were offered and sold as securities” on behalf of the fund and that these assets were maintained in “online trading accounts on crypto asset trading platforms” rather than at a qualified custodian, as required by the Custody Rule. Notably, the order does not provide any details about the crypto assets in question or how the SEC reached the conclusion that these assets were securities and so we are left to speculate as to whether these assets were offered and sold in a manner that clearly implicated the federal securities laws or if this was an instance of the SEC asserting an expansive view regarding the types of digital assets that they consider to be securities. In either case, advisers that invest in digital assets may want to revisit their custody arrangements in light of this action.