What to expect from the SEC in the year ahead

PEI PFC Forum 2013

Carlo V. di Florio, Director, United States Securities and Exchange Commission, Office of Compliance Inspections and Examinations

I expect the full text of his remarks will be published in the next few days, but these are my notes. They are live from the forum, so please excuse the typos.

It’s been a busy year for the SEC, with a big influx of private equity funds and other private fund managers. The SEC had lots of internal training in anticipation of private fund managers. They have many industry experts who are helping them analyze risk and train examiners.

The goal is still to subject most of the new registrants to presence exams. They have run about 140 exams so far.

DiFlorio_Carlo

The SEC still plans to publish a risk alert based on the findings from presence exams. We should expect it in the next 12-18 months.

In the marketing area, there are many firms with a very robust formal process for review. Others are informal and need some work.

In the portfolio management area, it’s allocation that is most problematic. You need a good process to show why you made an allocation to a particular fund.

In conflicts, it’s about fees that go to the fund manager instead of the portfolio company or being charged to the portfolio companies. There is also an allocation issue related to conflicts.

Valuation is another hot button. The SEC wants to see a good process. They want checks and balances. They want consistency in valuation procedures. Variations in process may be an indication of manipulation of valuations.

Zombie funds are a concern. The SEC does not want to see funds hanging on to assets merely to collect fees.

Private funds are moving into the retail space. As funds get exposed to retail investors, the SEC becomes more concerned.

Sometimes enforcement attorneys will accompany OCIE personnel on examinations. It’s a very small percentage of times. Usually, it’s for training purposes. Sometimes it’s to get a specialist from the investment management unit to help provide expertise. BUT sometimes, there has been a complaint and the enforcement person is looking at a specific issue.

Broker-dealer registration issues for fund managers is on the OCIE radar. He noted the David Blass speech on private funds and broker-dealer registration. They are seeing larger managers using an affiliate broker-dealer. Smaller funds are within the bounds of the issuer exemption. It’s fund managers in the middle that are falling afoul of broker-dealer registration issues. Dedicated marketing departments that get paid a commission are suspect.

He is seeing certain fund compensation as potential broker-dealer activity. If the fund manager is collecting a fee for raising debt or equity for a portfolio company, that could be an activity requiring broker-dealer registration.

Custody is an important focus in a post-Madoff world for the SEC. The SEC has found that private funds are struggling with the custody rule. For example, auditors are not PCAOB registered.

OCIE is impressed with how well many of the firms have put formal compliance plans in place. They are seeing that most private funds are taking the obligation very seriously. It’s the smaller firms that have more challenges when the CCO is wearing multiple hats.

OCIE really likes it when the CCOs are in the information flow. It’s great to see them in key meetings when decisions are being made. Crafting compliance to the business process is important.

He also mentioned that it’s great to see CCOs connecting with each other, like at this forum.

OCIE realizes that fund managers come in many shapes and sizes. They want to see meaningful compliance. They recognize that it can be more of a challenge at smaller firms.

SEC has submitted a budget request for 250 more examiners, most who would be dedicated to adviser examination. OCIE feels that there needs to be more examinations of advisers and fund managers. There is examination fee bill in Congress, sponsored by Maxine Walters. There has been an SRO bill on the floor, but it expired. He was not willing to place a wager on which option will come to fruition, if any.

Co-investment raises a conflict issue. The SEC is concerned about fair treatment. You should be concerned when fees are paid by the fund and not the co-investor or when opportunities are offered to a co-investor instead of the fund.

All firms received the presence exam welcome letter. Receipt of that letter was not an indication that the fund manager was on a review list. There was a rumor in the audience that only selected fund mangers received the letter.

Form PF will be part of the exam process. The market intelligence unit will use Form PF to identify risk and to highlight forms to exam. Examiners will have Form PF and be able to craft exam investigations around the information disclosed in the form.

To make an exam go smoother, what can a firm do. OCIE has tried to make the process more efficient. Make sure you have ready access to the information and people in the firm. Engage with the examiners and ask them questions.  OCIE imposes a 180-day limit on examinations. Generally, OCIE will reply back with 45 days after a response to a deficiency letter. OCIE will also commonly follow back to see if the changes have been implemented.