ADI 2025-16 - Registered Closed-End Funds of Private Funds

Registered closed-end funds that invest in private funds (“CE-FOPFs”) have increased in number and evolved since the first CE‑FOPF registration statement became effective in 2002.[1] Often in response to comments of Division staff (the “staff”), CE‑FOPFs that invest 15 percent or more of their assets in private funds have limited their offers to investors who qualify as “accredited investors” under Regulation D under the Securities Act of 1933 (the “1933 Act”) and have required minimum initial investments of at least $25,000.[2]

The Commission’s oversight of both registered funds and private fund advisers also has evolved significantly since 2002.[3] Market practices around the ongoing operations of both registered investment companies and private funds have also developed over the past two decades. As a result, and as previously announced, when reviewing CE‑FOPF registration statements, the staff will no longer provide comments requesting the registrant either (i) include accredited investor status and minimum investment requirements or (ii) limit its private fund investments to 15 percent of its assets.[4]

Regulatory Protections

Investors in CE-FOPFs who indirectly invest in private funds have regulatory protections under the federal securities laws that differ from the safeguards afforded to direct investors in private funds. These protections include requirements that:

• the CE-FOPF be managed by a registered investment adviser, which owes a fiduciary duty to the fund;
• a board of directors, which also owes a fiduciary duty to the fund, exercises oversight of the CE-FOPF; and
• the CE-FOPF make certain periodic disclosures and bear liability for material omissions and misstatements.[5]

The 1940 Act, which applies to CE-FOPFs, and the rules promulgated thereunder also set forth requirements designed to protect investors, including with respect to board governance, mandatory compliance programs, limits against excessive leverage, and limits on overly complex capital structures. Furthermore, the 1940 Act prohibits certain conflicted transactions with affiliates, which, among other things, generally would preclude a registered closed‑end fund from investing in an affiliated private fund.[6]

Disclosures

The staff is publishing this ADI to highlight areas that the staff, when reviewing CE-FOPF registration statements, has focused on—and will continue to focus on—to promote retail investor understanding of CE‑FOPFs in making informed investment decisions. The staff wants to emphasize that, registration statement disclosures should be clear, concise, and understandable, and must comply with the Commission’s “plain English” rule.[7]

A closed-end fund’s registration statement must disclose all of the information required by Form N-2, which is designed to assist closed‑end fund investors in making an informed investment decision. Consistent with existing obligations to disclose material information,[8] a CE‑FOPF should provide full disclosure of its costs, strategies, and risks, as well as the investment process-related due diligence practices conducted by the adviser when evaluating private fund investment opportunities (including investment, operational, legal, and, as applicable, tax considerations).[9] The liquidity terms of the CE-FOPF also should be disclosed clearly and prominently.

For the fee- and cost-related disclosures in its registration statement, a CE‑FOPF should describe the various fee structures imposed by the underlying private funds (including performance‑related compensation) and discuss how those fees could affect the underlying private funds’ returns and the CE-FOPF’s performance. A CE‑FOPF should also disclose how multiple layers of direct and indirect fees will affect the returns realized by an investor in the CE-FOPF. In particular, a CE‑FOPF should consider disclosing the effect of any underlying private fund performance fees or incentive allocations on the CE‑FOPF’s performance, including the possibility that certain of the underlying private funds may receive performance fees, even if other underlying private funds—or the overall performance of the CE‑FOPF itself—is negative (i.e., “netting risk”).

CE-FOPFs should consider making sufficient disclosures about the underlying private funds themselves. For example, in its strategy and risk disclosures, a CE-FOPF should provide a full discussion of the types of underlying private funds in which it proposes to invest and the associated risks and considerations, including (to the extent material) the private funds’ investment strategies, risks associated with more volatile or speculative investments, conflicts of interest, and the liquidity of the private funds’ underlying investments.

CE‑FOPFs should also disclose that:

• the underlying private funds in which they invest (as compared to registered funds) are not limited by the 1940 Act in how they invest their assets (e.g., leverage and transactions with affiliates); and
• the underlying private funds’ investments may impact the strategies, risks, and costs of and for the CE‑FOPF itself. The CE‑FOPF should disclose that shareholders may have limited information about the underlying private funds in which it is investing, including with respect to the underlying private funds’ holdings, liquidity, and valuation.[10]

Where material, a CE-FOPF should consider disclosing risks relating to:

• the legal jurisdictions of the underlying private funds;
• “liquidity terms” for its private fund investments (such as mandatory minimum holding periods, limitations or suspensions of redemptions, and the possibility of “payment in kind” distributions in response to a redemption request) and explaining how these terms may impact the fees, performance, and liquidity of the CE‑FOPF; and
• tax considerations when investing in private funds that produce non-qualifying income and that could impact the CE-FOPF’s pass-through status as a Regulated Investment Company (“RIC”) under Subchapter M of the Internal Revenue Code.

Filings

CE‑FOPFs currently operating and that have invested (or seek to invest) over 15 percent of their assets in private funds and have removed, or now seek to remove, accredited investor and/or investment minimum shareholder limitations from their registration statements should (i) file amendments to their registration statements through rule 486(a)-(b) under the 1933 Act or (ii) file prospectus supplement updates through rule 424 under the 1933 Act, as appropriate. These CE-FOPFs should consider whether the cumulative changes incorporated in those amendments and updates (including any changes in addition to removing the accredited investor and investment minimum shareholder limitations) are material, which would require the staff’s review under rule 486(a).

Registrants that currently limit private fund exposure to 15 percent of assets and never imposed accredited investor and/or investment minimum shareholder limitations in their registration statements and now seek to remove the 15% limitation should reflect such changes through a post‑effective amendment filing under rule 486(a), as such a change is material and should be reviewed by staff.

The Division encourages registrants to engage with the staff to determine what filings and disclosures are appropriate for closed‑end funds that are CE‑FOPFs.

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ADIs are recurring publications that summarize the staff’s views regarding various requirements of the federal securities laws.

The statements in this ADI represent the views of the staff of the Division of Investment Management. This ADI is not a rule, regulation, or statement of the Securities and Exchange Commission. Further, the Commission has neither approved nor disapproved its content. This ADI, like all of the staff’s statements, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person. Future changes in rules, regulations, and/or the staff’s no‑action and interpretive positions may supersede some or all of the information in a particular ADI.

We hope that this ADI will assist registrants in complying with their disclosure requirements. We also welcome feedback on this ADI and on any disclosure matters. If you have any questions or feedback, please contact:

Disclosure Review and Accounting Office

Phone: 202.551.6921

Email: IMDRAO@sec.gov

Chief Counsel’s Office

Phone: 202.551.6825

Email: IMOCC@sec.gov