FINRA Issues Regulatory Notice on Communications Regarding Real Estate Investments

finra

FINRA issued Regulatory Notice 13-18 on compliance with the communications with the public rule concerning communications about unlisted REITS and other real estate investments.  Among other things, FINRA is concerned about the use of pictures of real property in the marketing materials.

FINRA Rule 2210 regulates broker-dealer communications with the public. Clearly, based on the Regulatory Notice, FINRA is concerned about disclosures and marketing when it comes to private real estate. The Regulatory is focused on private REITs and direct participation plans, not private equity real estate. However, the guidance may be applicable to a placement agent involved in fundraising.

It was the limitation on pictures that caught my attention. One of the unique aspects of real estate funds is that you can show pictures of the investments. There is little guidance on how you need to treat the pictures or whether the pictures could be considered misleading. So the FINRA Regualtory Notice caught my eye.

Communications for a new program often include photographs or other images of properties owned by investments managed by the program’s sponsor that are similar to properties the program expects to purchase. In order to be clear that investors will not acquire an interest in the pictured property, prominent text must accompany each depiction explaining that the property is owned by an investment managed by the sponsor and not the program. Once the real estate program has acquired a portfolio, the communication may include depictions of properties that are limited to investments owned by the program.

That’s not much of a help. You can’t include pictures of non-fund properties unless you disclose that they are owned by a different fund.

Private Equity Real Estate 50: Which are Registered with the SEC?

pere 50

Private Equity Real Estate just released its ranking of the top 50 real estate private equity fund managers. As I have done in the past, I parsed the list to see which managers are registered with the Securities and Exchange Commission as investment advisers. (Disclosure: my company is on the list.)

1 The Blackstone Group Registered
2 Starwood Capital Group Registered
3 Lone Star Funds (Hudson Advisors) Registered
4 Colony Capital Registered
5 LaSalle Investment Management Registered
6 Tishman Speyer Registered
7 The Carlyle Group Registered
8 Goldman Sachs Real Estate Principal Investment Area Registered
9 Brookfield Asset Management Registered
10 MGPA Registered
11 Morgan Stanley Real Estate Investing Registered
12 CBRE Global Investors Registered
13 Westbrook Partners Registered
14 AREA Property Partners Registered
15 Angelo, Gordon & Co Registered
16 Prudential Real Estate Investors Registered
17 Shorenstein Properties
18 CapitaLand Overseas
19 Fortress Investment Registered
20 TA Associates Realty Registered
21 Oaktree Registered
22 Bank of America Merrill Lynch Global Principal Investments Registered
23 Walton Street Capital Registered
24 Northwood Investors Registered
25 Perella Weinberg Partners Registered
26 Lubert-Adler Real Estate Registered
27 AEW Global Registered
28 Beacon Capital Partners Registered
29 Orion Capital Registered (overseas)
30 Alpha Investment Partners Overseas
31 DRA Advisors Registered
32 KSL Capital Registered
33 ARA Asset Management Overseas
34 Rockpoint Group Registered
35 Niam Overseas
36 Hemisferio Sul Investimentos Overseas
37 Hines Registered
38 GI Partners Registered
39 Cerberus Capital Registered
40 GTIS Partners Registered
41 Invesco Real Estate Registered
42 Crow Family Registered
43 CIM Group
44 Rockwood Capital Registered
45 Berkshire Property Advisors Registered
46 Harrison Street Real Estate Capital Registered
47 GE Capital Real Estate
48 Kayne Anderson Real Estate Registered
49 Spear Street Capital
50 Stockbridge Capital Registered

 

PERE expanded the list this year from 30 to 50.  On the list, 41 of the top 50 are registered with the SEC as investment advisers. Of those not registered, 5 are overseas and likely are outside the scope of SEC registration requirements.

There are good arguments to be made on both sides of the registration debate for real estate funds. The core requirement under the Investment Advisers Act is that the manager is giving investment advice about securities. Most of these real estate fund managers are truly focused on real estate and not securities. However, the discussion between what is and is not a security may be fun for the first week of your securities law class in law school. It’s not a fun discussion when trying to comply with regulatory requirements.

The PERE 50 measures capital raised for direct real estate investment through commingled vehicles, together with co-investment capital, over the past five years.

Sources:

Compliance Bricks and Mortar for May 3

bricks header 3

These are some of the compliance-related stories that recently caught my attention.

SAC to Begin Clawing Back Compensation in Insider Trading Cases by Peter Lattman in DealBook

On Thursday, Mr. Cohen sought to convince SAC investors and regulators that he takes compliance seriously. In a letter to his investors, Mr. Cohen announced a broad set of changes that would bolster the fund’s compliance practices, including clawing back the pay of employees who violate the law.

steve-cohen-insider-trading-case.i.0.steve-cohen-andre-carrilho

The Hunt for Steve Cohen By Bryan Burrough and Bethany McLean in Vanity Fair

With arrest after arrest in a massive, seven-year insider-trading investigation, U.S. Attorney Preet Bharara is getting closer to the biggest fish of them all: Steve Cohen, founder of SAC Capital, the $14 billion hedge fund, who some regard as the most successful stock picker of his time. C.E.O.’s have fallen, lives and companies have been upturned, but Cohen has thus far escaped. Bryan Burrough and Bethany McLean go deep inside Bharara’s probe—and SAC’s org chart—to reveal just how much blood is in Wall Street’s waters.

Prison For Illinois Men Who Hatched Comic Book Ponzi Scheme From Prison by Jordan D. Maglich in Ponzitracker

Three Illinois men are headed back to federal prison for masterminding a Ponzi scheme they concocted in prison that promised lucrative returns through the distribution of comic book rights.  Daniel Parrilli, 62, John Lauer, 48, and Christopher Anderson, 57, received 70-month, 31-month, and 95-month prison sentences, respectively, after previously pleading guilty to fraud charges.  The scheme raised more than $7 million from over 150 investors.

SEC Dings Investment Adviser for Custody Violations, Failure to Supervise by David Smyth and Elizabeth E. Spainhour in Cady Bar the Door

Readers of this space – and SEC observers generally – will recall a March 4 risk alert designed to warn investors about the ways U.S. investment advisers had recently been found to have violated the SEC’s asset custody rule.  The number and variety of violations were legion.  Advisers were not assuring themselves that clients were receiving quarterly account statements.  They weren’t subjecting themselves to surprise examinations designed to assure compliance with the rule.  The list went on, and the Commission’s Office of Compliance Inspections and Examinations closed with a polite reminder that “[a]dvisers may want to consider their policies and procedures and their compliance with the custody rule in light of the deficiencies noted in this Alert.”

Day Two at PEI’s Private Fund Compliance Forum

PEI PFC Forum 2013

These are my notes from the Thursday sessions at PEI Media’s Private Fund Compliance Forum 2013.

The Day started out with a closed door session called the CCO Think Tank. Since the doors were closed, I’m not going to share any specific notes.

The public sessions:

What’s on the regulatory horizon and how will it affect your compliance program

Panel members:
Christian B. McGrath, Managing Director & General Counsel, GTCR
Jason Mulvihill, General Counsel, Private Equity Growth Capital Council
Joel Wattenbarger, Partner, Ropes & Gray LLP

How technology can improve your compliance process

Jacqueline M. Giammarco, Esq., Chief Compliance Officer, Stone Point Capital
Stephen Pope, East Regional Sales Manager, Smarsh
Shawn Pride, Partner, Ernst & Young LLP
Arthur Zuckerman, Chief Operating Officer, Chief Compliance Officer & Partner, Avista Capital Partners

Ensuring compliance in your marketing and solicitation procedures

Paula Bosco, Managing Director, Chief Regulatory Counsel & CCO, New Mountain Capital, LLC
Abrielle Rosenthal, Senior Principal & Senior Compliance Counsel, TowerBrook Capital Partners L.P.

You can also see my notes from Day One at PEI’s Private Fund Compliance Forum.

The Forum was a great event for compliance professionals at private funds. The issues at funds does differ significantly than it does for retail investors. There was a strong showing from private equity and real estate fund managers.

Like any good conference, the interactions outside the formal programs was even more useful.

Ensuring compliance in your marketing and solicitation procedures

PEI PFC Forum 2013

These are my notes from the Private Fund Compliance Forum 2013.

Paula Bosco, Managing Director, Chief Regulatory Counsel & CCO, New Mountain Capital, LLC
Abrielle Rosenthal, Senior Principal & Senior Compliance Counsel, TowerBrook Capital Partners L.P.

The JOBS Act is going to change things. We just don’t know when or how. However, most people think it will just reduce risks associated with speaking at conferences and speaking to the press.  A poll of the audience showed only 6% would advertise widely, 34% would advertise in small institutional circles, and 60% would not change their marketing practices.

You want to make sure you define terms like Gross IRR and return on equity.  Of course, all gross numbers must be accompanied by net numbers.

You want your footnotes to be at least 8pt, otherwise its unreadable.

You want every statement in the materials to have a source and to be backed by data. You especially need to have the supporting data for past performance numbers.

You can treat communications to current investors communicating current fund performance as not being marketing materials. The danger is that the materials get delivered to a prospective investor as part of the marketing pitch.

Be sure to be consistent across the Form ADV and responses to DDQs and other marketing materials.

The session turned to the big, ugly, hairy gorilla known as AIFMD. If you are not actively marketing in Europe and don’t have any Europe fund operations then you probably don’t have to worry about AIFMD.

However, there are three areas that may still trigger AIFMD: co-investments, secondary transfers, and equity structures.

If you are allowing co-investments from European investors that could trigger AIFMD. If an investor sells an interest to a European investor it may trigger AIFMD.

Local laws on lobbying and pay-to-play can be time consuming.

Remember that the anti-fraud rules apply to all communications, not just marketing. You can never be misleading.

How technology can improve your compliance process

PEI PFC Forum 2013

These are my notes from the Private Fund Compliance Forum 2013.

Jacqueline M. Giammarco, Esq., Chief Compliance Officer, Stone Point Capital
Stephen Pope, East Regional Sales Manager, Smarsh
Shawn Pride, Partner, Ernst & Young LLP
Arthur Zuckerman, Chief Operating Officer, Chief Compliance Officer & Partner, Avista Capital Partners

Think about how the technology can help your business processes, not just the compliance process. It’s better to leverage the business process and improve it.

A particular good starting point is investor on-boarding and automating the subscription process.

Employee trading is one area, particularly for private equity and real estate, that is a compliance nuisance. There is little risk in the fund managers operations. Technology can help eliminate the bureaucratic and time-sink processes mandated by the Adviser Act rules. Automating the process removes the stacks of paper from the office and means that the CCO and staff do not have to stare at all of the trades, just exceptions.

There was pitch for Compliance 11, not just for securities monitoring, but also for case management and tracking other compliance processes.

Vendors should be SSAE16 certified so they are taking the proper steps to protect your data.

Few attendees used technology to upload Form PF. One attendee said to was expensive and seemed to regret using it.

Don’t establish policies to monitor email and social media if you won’t have the time to actually monitor them.

What’s on the regulatory horizon and how will it affect your compliance program

PEI PFC Forum 2013

These are my notes from the Private Fund Compliance Forum 2013. They are live notes, so please forgive my typos.

Christian B. McGrath, Managing Director & General Counsel, GTCR
Jason Mulvihill, General Counsel, Private Equity Growth Capital Council
Joel Wattenbarger, Partner, Ropes & Gray LLP

Broker-dealer regulation in connection with the sale of private fund interests is an upcoming topic. The  David Blass speech on private funds and broker-dealer registration highlights the issue. If you have internal marketing people who are getting paid transaction based compensation for selling fund interests, there may be an issue.

The second issue for private equity is the manager getting fees for portfolio fee transactions that look like a securities offering for compensation.  This may be lessened by having advisor fee offsets. This is an evolving issue. It’s not all fees, just fees for transactions like raising equity or debt on behalf of the portfolio company.

There has been some discussion by the SEC about revising the advisor regulations as they apply to private funds. They see some issues with the applicability of some of the regulations.

According to unnamed sources, lifting the ban on general advertising and solicitation is a priority of the new SEC Chairman. The big question is what the final rule will look like. In particular is the issue of how you confirm that someone is an accredited investor. It’s likely that you will still be able to do a quiet 506 offering under the existing requirements. There is still a prohibition on public advertising under the CFTC 4.13(a)(3) exemption for de minimis commodities trading.

FATCA is coming online at the beginning of 2014. You may need to get more information from foreign investors.

 

Day One at PEI’s Private Fund Compliance Forum

PEI PFC Forum 2013

These are my notes from the various sessions at the Private Fund Compliance Forum 2013.

The SEC is coming! The SEC is coming!

PEI PFC Forum 2013

These are my notes from the Private Fund Compliance Forum 2013. They are live notes, so please excuse my typos.

One thing that this past year has shown us is that at some point or another, sooner rather than later, the SEC will come knocking. This session will show you how to effectively prepare for their
arrival.

Tracey M. Chaffin, CFO & Partner, Pamlico Capital
Theodore E. Eichenlaub, Principal, ACA Compliance Group
Blair Flicker, General Counsel, Insight Venture Partners
Kelly S. Hale, Director of Compliance, TA Associates
Lois Towers, Chief Compliance Officer, Pantheon Ventures

Have your policies and procedures organized and available for ready access. Don’t have policies that you can’t or won’t follow. You’ll need some evidence that you are following the policies and procedures.

Prepare with a mock exam. Have key employees sit down and subject themselves to an interview. It will help you to see which employees will shine and which need more preparation.

Try a dry run with a document request letter. Grab one of the presence letters and pull all the documents requested.

Prepare an introductory presentation.

  • Who you are
  • how you make money
  • who are the key employees
  • what is your business model

This presentation can steer them away from issues that are not applicable to the firm’s business model. Don’t use an investor pitch, although you can use key parts. You want to introduce the firm. You want to stay away from portfolio details and past performance. It’s good to have some meet and greet with senior people. Having senior people introduce themselves helps to show to the SEC that you are taking compliance and the SEC presence seriously.

Make sure you have a log of every document you give them and keep a duplicate copy. If you provide documents electronically, its better to produce them in pdf instead of native format.

You can make some documents subject to a FOIA request. You can request that everything is subject. The process is detailed.

Alert employees to the upcoming visit from the SEC. Clean desks, don’t leave documents on the copier, and don’t talk about deals in public places.

Dedicate a room for them. You can lock it for them at the end of the day. The room need not be in the center of the operations. It may be better to keep them off to the side so they are not exposed to things that may inadvertently catch the examiners attention. Designate one person to be available at all times. Generally it’s the CCO.

Be aware that the examiner may not be able to accept food or beverages. Maybe a cup of coffee. So be careful about being too cordial.

Coach your employees before they sit down with the examiners. Have the answers be concise and brief. Make sure the employees are willing to respond to multiple questions that are similar. The examiner may not understand the response.

You should request an exit interview. It is very useful.

What to do if an investor asks for a copy of the deficiency letter? Don’t deliver a copy, but provide a summary. A deficiency letter is not public. Don’t misrepresent the nature of the exam or the contents of the letter.

You have 30 days to respond to the SEC deficiency letter.

What does the CFTC have to do with private equity?

PEI PFC Forum 2013

These are my notes from the Private Fund Compliance Forum 2013. They are live from the Forum so please forgive my typos.

Robert E. Phay, Jr., Associate General Counsel & Chief Compliance Officer, Commonfund

The common sense answer should be “nothing”. But that does not seem to be the case. The CFTC seems to be trying to broaden its grasp.

Dodd-Frank pulled interest rate derivatives and foreign exchange derivatives into the definition of a “commodity”.

Interest rate swaps and foreign exchange hedges are now commodities so trading in those could trigger CFTC registration. There is an exemption under Rule 4.13(a)(3) called the de minimis rule. You have to have less 5% of the liquidation value of the fund in commodities or the notional value is less than 100% of the fund value.

Regulation 4.13(a)(3) requires that the trading limits must be complied with “at all times.” However, the provisions of Regulation 4.13(a)(3) qualify that requirement, stating that such limits are determined “at the time the most recent position was established.” When these requirements are read together, staff believes that it is clear that the regulation only requires that a CPO be in compliance with the trading thresholds at the time a position is established. A CPO would not otherwise be required to reconfigure its portfolio to comply with such limits.

If you have more commodities in excess of the de minimis amounts then you need to worry about other registration and the requirements of the Commodities Exchange Act.

Fund of funds have special rules under 4.13(a)(3) with a look through to the underlying funds.

This all ties back to the jurisdiction over swaps and adherence to the ISDA protocol.

There is a Department of the Treasury exemption for Foreign exchange swaps and forwards. You still need to adhere to the ISDA protocol for these. You just don’t need to comply with the central clearing requirement. It’s not an exemption from the business conduct rule.

The Commodity Exchange Act definition of “commodity pool”:

(10) Commodity pool

(A) In general
The term “commodity pool” means any investment trust, syndicate, or similar form of enterprise operated for the purpose of trading in commodity interests, including any—

(i) commodity for future delivery, security futures product, or swap;
(ii) agreement, contract, or transaction described in section 2 (c)(2)(C)(i) of this title or section 2 (c)(2)(D)(i) of this title;
(iii) commodity option authorized under section 6c of this title; or
(iv) leverage transaction authorized under section 23 of this title.