These are my notes from this session at PEI’s Private Fund Compliance Forum.
The SEC is developing an approach of zero tolerance for non-compliance. Private funds are challenging because there are some that have been registered fro many years and many that have only been registered for two years.
The SEC is learning more about the private fund space and will increasingly be taking a more detailed look.
Some funds that have been registered for a longer period time are increasing their compliance staff and increasing the scope of compliance oversight. Firms that have CCOs wearing two hats have been splitting the role and putting a dedicated CCO in place. There is increasing SEC oversight and a rapidly changing regulatory landscape.
In looking at compliance risks versus business risks, one key is whether you are willing to have a compliance weakness in that area potential be exposed in a deficiency letter from an SEC exam.
One area particular for private equity is the use of related party service providers. The panel provided the example of a portfolio company doing an executive search and used a recruiting company that was another portfolio company controlled by the private fund.
The panel discussed JOBS Act compliance when it comes to meeting the new standard for taking reasonable steps to ascertain that an investor is an accredited investor. Funds are not using general solicitation and advertising because of the uncertainty around the requirements. The safe harbors are inappropriate for private funds. The audience voted that 25% would not use it because of the reputation risk. But half the audience confirmed that it was the uncertainty. Too many risks for too little gain.
The next topic was changes in the business practices of the fund after closing. Obviously the first analysis is whether the change is permitted by the LP Agreement. IF not, make sure that you get the appropriate consent from the LPs.
The next topic was pitchbooks and marketing materials. The SEC has expressed displeasure with one-on-one meeting materials that merely switch cover pages from investor to investor. That converts the materials into marketing materials.
The next topic was AIFMD compliance. Do we think the SEC will focus on this topic? Probably not. But you need to deal with the foreign regulatory authorities. Unfortunately it’s a rapidly evolving landscape. Many firms are saying that it’s not worth the effort to figure it out and are ignoring Europe at a source for investors. The term “marketing” varies from country to country in the EU. That means you may have multiple version of marketing materials to meet the multiple requirements.
Cybersecurity. The SEC document request for cybersecurity is incredibly complex and most private funds are going to have trouble with it. One area to focus on is the potential vulnerabilities in service providers that link into your systems. You should put together a plan and start a review to at least show that you are focused on the issue. (Because the SEC is focused on the issue.) Should compliance own this? Probably not. Most CCOs are not going to have the expertise. It’s probably better to have IT own it. One discussion is who should pay for it. Should cybersecurity be a fund expense or a management company expense. The audience and panel overwhelming took the position that it is a management company expense.
The next topic was FCPA. Make sure you do your diligence on foreign investments. With a focus on expenses, bribes and corrupt payments could end up in exam review.
The last topic was what keeps you awake at night. From the panel:
- The rapidly changing regulatory landscape
- Cybersecurity – that SEC doc request is scary
- FCPA – it’s hard to find the bad activity
- AIFMD
