Category: Conference Notes

These are my notes, live from the forum. (Please pardon the rougher nature.)

Speaker:
Marc Wyatt , Deputy Director -Office of Compliance Inspections and Examination, US Securities and Exchange Commission

(Of course, his comments are his own and don’t represent the viewpoints of the Commission or the rest of the staff.) This also only his 16th day in this position.

The “presence exam initiative” was a response to the flood of new registrants coming from Dodd-Frank. The SEC wants to push the results back to the firms.

Capital formation is important. The private equity industry has grown 25% and capital raised has increased by 40% over the last few years. The size of funds currently being marketed is down 14%.

He interprets that the SEC’s oversight is not impeding capital formation.

OCIE’s private fund unit wants to conduct targeted risk-based exams to ensure compliance. The unit spreads the results throughout OCIE to keep examiners aware of risks and what to look for. The unit is also running training sessions for the large population of examiners.

Based on last year’s speech by Bowden, investors are focused on fees.

Disclosures on Form ADV does not work if the disclosure is not made until after the investor comes into the fund.  Get consent if you imposing a new fee or expense.

The SEC is happy to seeing a split between the general counsel and chief compliance officer role.

There is still room for improvement.

By far the most common deficiencies noted by our examiners in private equity relate to expenses and expense allocation. Many managers still seem to take the position that if investors have not yet discovered and objected to their expense allocation methodology, then it must be legitimate and consistent with their fiduciary duty.

Co-investment allocation is an area of concern. All investors must understand where they stand.

In addition to the SEC’s focus on traditional private equity, the National Examination Program began utilizing our Private Funds Unit to systematically look at private equity real estate advisers. There was an observation that real estate managers, especially those executing opportunistic and value-add strategies, tended to be much more vertically integrated than traditional private equity managers.

They found that some ancillary services are not disclosed. More often they found that the manager would charge these additional fees based on the understanding that the fees would be at or below a market rate. Unfortunately, the SEC fund that the manager was not able to substantiate claims that such fees are “at market or lower.” The SEC saw that the managers collects no data to justify their fees at all. Other times, the data is collected informally through calls to other industry participants and is not documented.

I hope that private equity real estate managers who have promised to provide their investors with “rates at or below market rate” review their benchmarking practices to ensure they can support their claims.

We can expect additional enforcement recommendations involving undisclosed and misallocated fees and expenses as well as conflicts of interest.

The speech was published during the session.  Here it is: Private Equity: A Look Back and a Glimpse Ahead.

Post-speech questions and comments:

OCIE wants to be risk-based, data-driven, and transparent. They don’t want to be a “gotcha” regulator.

How do you get the examiners out of the office faster? Give them accurate and consistent responses quickly. Don’t cross-talk. Make sure you understand the question and understand the definition/terminology. If you data-dump that will slow down the process. If you give the examiners 700 documents, they will have 700 documents to read and that takes time.

Exempt reporting registrants? The SEC will show up if there is a TCR or a sweep.

He looks at CCOs as colleagues to help spread compliance. CCO liability situations came from egregious behavior (Blackstone aside.)

These are my notes, live from the forum. (Please pardon the rougher nature.)

Speaker:
Julia D. Corelli, Partner, Pepper Hamilton
Ross A. Oliver, Senior Counsel & Chief Compliance Officer, Crestview Partners
Gwen Reinke, Chief Compliance Officer, Vista Equity Partners

You need to think of marketing as a broader area than advertising.

Deal press releases and portfolio company press releases may describe the firm. Make sure it meets the standards. Your website is marketing.

How do you monitor compliance with your policy? Set up the Google search. Look at employee LinkedIn accounts.

You should on-board new employees to make sure they understand the dos and don’ts, followed by annual training.

Are private funds using general solicitation under 506(c)? The proposed rules have raised many unknowns about the downside to using it. Many are skeptical through true general advertising would be a good way to reach potential investors. Some funds are using to avoid the common foot-faults. (like speaking at a conference.)

The SEC has increased its review of marketing materials as part of its examinations. One focus it the inclusion of GP or other non-fee paying LPs in the performance data.

Prospective investors want to see case studies. The regulatory concern is that it could be considered cherry-picking. Best practice is to include a list of all investments with performance results.

When it comes to net returns there was a split in the audience poll. Half calculated as if everyone paid the highest fee, and the other half exclude non-fee or reduced fee investors in the calculation. Regardless of the choice, you need to disclose.

When it comes to books and records, remember you need to keep the performance backup materials for at least five years after last used.

These are my notes, live from the forum. (Please pardon the rougher nature of this report.)

Speakers:
Terry E. Everett, CFO & COO, Rockland Capital
Garth Nichols, Senior Manager- Financial Services, EY
Christopher Anderson, CCO & General Counsel, KPS Capital Partners LP

First step is to figure out what you want to protect. For private equity and real estate funds the information may be all over the place. It’s not not just a client account database.

It’s not just about digital access, but also physical access. Figure out if people can get into your offices and if they do get in, what can can they get easy access to. Walk around and see if people have passwords stuck to their monitors.

Assess where risks may be coming from. Protect the higher risks.

Look to third parties that you share sensitive information with. Look at their program to make sure it’s up to your standard and not a vulnerability.

Your employees are likely your weakest link. Phishing and spearphishing are common attacks. Accidents happen: employees lose laptops and phones that may offer access to your systems.

You should be able to show that you have been thoughtful, have a plan a place to review, and a plan in place to deal with a breach.

These are my notes, live from the forum. (Please pardon the rougher nature.)

Speakers:
Jason Brown, Partner, Ropes & Gray
James Gaven, Senior Counsel and Chief Compliance Officer ,Welsh, Carson, Anderson & Stowe
Byron Pavano, COO & Fund Counsel, Audax Group
Abrielle Rosenthal, Managing Director, Chief Compliance Officer, TowerBrook Capital Partners LP

The new registrant presence exam initiative is over. What’s next?

The exams are much more focused than when the presence exam started. Requests across regional offices are looking more similar. SEC personnel are getting more knowledgeable. Enforcement actions are coming.

Work hard to get documents in by the deadline or before the deadline to the SEC examiners. Speed makes you look good.

Don’t underestimate the importance of the process. Make sure you know who is going to do what. Decide who to notify. Plan on how to leverage outside counsel and consultants to help with the process.

Focus on how to use attorney-client privilege for disclosure. It does change the tenor of the exam process.

How to stay ready for an exam.

Mock audits. Maybe it’s better to have a deeper dive on specific issues than a full audit.

Grab an example of a request list and make sure you can get all of the documents.

Have a day one pack ready at all times, with an introductory presentation.

The SEC will be focused on fees and expenses. Make sure you have that information put together. Examiners are focused on the allocation of expenses between the funds and the management company. Keep an eye on broken deal expenses. Focus on employee/consultant/operating partner expenses. The SEC will be looking at a general ledger and deep-diving.

Are examiners giving credit to ADV and LPAC disclosures? It seems to be a mixed bag. You definitely can’t amend the LPA through the ADV. It won’t save you if there is an actual issue. Don’t say “may” if you are actually doing the act and always doing it.

Accelerated monitoring fees are continuing to be a hot button. It’s moving from a deficiency to an enforcement action.

You need to be accurate and full-some in your responses. You also need to make sure you understand the question. The SEC questions tend be one-side fits all. You don’t need to answer more than what is asked.

Consultant versus employee and charging to the portfolio companies. If the person is exclusive, then the SEC is going to take the default position that the person is an employee, regardless of how the firm treats the person.

Valuation is continuing to be a focus are for the SEC when examining private funds, private equity and real estate in particular. The SEC will want to see what caused changes in valuation. The focus is on good process. The SEC has hired evaluation experts. The examiners are challenging underlying assumptions. Of course, examiners are looking for documentation.

Allocation of opportunities has been a point of focus. Examiners are looking for allocations among funds and allocations among co-investors. The key is to disclose what you are going to do and to make sure you follow that disclosure. It’s okay to cherry-pick as long as that what was disclosed.

In at one exam, there was  side letter in which the investor expressed an interest in co-investment opportunities. The examiners determined that that provision required the manager notify when there was a co-investment even if that opportunity was not offered to that investor.

The Custody Rule is still a tough fit for private equity firms. They are looking for thoughtful consideration of the rule.