Tag: Marc Wyatt

Discover the Priorities and Perspectives of the Office of Compliance Inspections and Examinations

coping with regulatory change

I’m attending a conference sponsored by IA Watch: Coping with Regulatory Change. These are my brief notes.

Marc Wyatt, Director, SEC’s Office of Compliance Inspections and Examinations, gave his perspective on the priorities that lie ahead for OCIE. Marc Wyatt Named Director of the Office of Compliance Inspections and Examinations last week.

He emphasized that OCIE does not want to be a “gotcha” regulator. OCIE’s job is deterrence. That is why OCIE publishes its exam priorities each year. OCIE wants to empower CCOs to be able to focus limited resources on issues. It’s not that OCIE only gets to 10% of registered advisers. OCIE wants to use the exams to deter other firms from doing bad things. Exams are very much risk-based and data driven.

Cybersecurity will be on the list for a long time. Retirement accounts and senior investors will also be on the list.

OCIE tries to be incremental. For cybersecurity, the first round was mostly information gathering. The next level is more testing. He was not willing to say how many firms OCIE is visiting. He wants it be statistically significant.

The pool of registrants is growing. There were 500 new registrants last year. The SEC is trying to specialize and get the skills for the new pool of registrants (private equity, hedge funds, etc.)

OCIE feels it is getting better aligned with institutional investors. Investors are doing much more due diligence and taking a deeper dive.

The vetting process for which firms to exam is also a set of data for the exam process. Of the two out of ten firms that examined, reviewing the other eight helps OCIE understand the risks.

How to avoid getting examined? These are red flags for the risk-based analysis:

  • A big swing in AUM?
  • Changes in key personnel
  • Aberrational performance
  • Areas for better understanding (OCIE wants to better understand a time of investing style, or there is a rule in process)

How to get exam staff out once they come:

  • Be efficient on document production
  • Question the exam staff about unclear document requests
  • Get clarification if a question is unclear.
  • Don’t dump documents trying to overload examiners
  • Make sure exam staff has access to key people
  • Day One presentation with CCO, being candid about risks, highlighting key people for follow-up meetings

In response to lowering risk rating, Mr. Wyatt was not willing to share criteria that would reduce. He pointed out there is a never-before examined exam initiative.

He pointed out the out-sourced CCO risk alert. Use that to look at your in-house CCO program.

Compliance and Co-Investment Allocation

Icon of Money in the Hand on Rusty Warning Sign.

Co-investment is an area that many institutional investors look for when investing with a fund manager. It’s generally a good deal for them because the investment is overseen by the fund manager without having to pay the fund management fee. Depending on the program, it may be a lesser fee or no fee. And of course they still have to pay the expenses charged by the fund manager to the portfolio company. The fund manager gets more capital to invest and can reduce the exposure of the fund to a particular investment. The fund manager is likely earning less of a fee for doing the same amount of work.

It does not seem like an area that is ripe with the conflicts and issues that grab the attention of the Securities and Exchange Commission. However, Marc Wyatt, the Acting Director, Office of Compliance Inspections and Examinations, chose to spend a few minutes raising the issue during his speech at the recent Private Fund Compliance Forum.

Another area where we have been dedicating resources is co-investment allocation. We’ve spoken before about our observation that co-investment allocation was becoming a key part of an investor’s thesis in allocating to a particular private equity fund, and over the past year, co-investments have become even more important to the industry.

If the SEC is dedicating some of its limited resources in this area, we should take notice.

While most of our co-investment observations have been around policies and procedures, we have detected several instances where investors in a fund were not aware that another investor negotiated priority co-investment rights. … Therefore, allocating co-investment opportunities in a manner that is contrary to what you have promised your investors can be a material conflict and can result in violations of federal securities laws and regulations.

From that quote it seems the SEC exam team has encountered situations where a fund manager was misleading investors about co-investment rights. Clearly, you can’t promise an investor something and then do the opposite.

Ironically, many in the industry have responded to our focus by disclosing less about co-investment allocation rather than more under the theory that if an adviser does not promise their investors anything, that adviser cannot be held to account.

Many fund managers do keep their co-investment allocations under wraps, doling them out in a manner that works best for the deal. There are many factors that go into partnering up with investor through a co-investment. The co-investor needs to be able make capital available and make decisions as quickly as the fund manager. Otherwise strategic decisions are jeopardized. The need for a co-investment may vary over the course of the fund life. Deals maybe smaller and not be good opportunities for co-investments.

I believe that the best way to avoid this risk is to have a robust and detailed co-investment allocation policy which is shared with all investors. … I am suggesting that all investors deserve to know where they stand in the co-investment priority stack.

I’m not sure I know what to make of that. Most investors do not have co-investment rights and have no expectation of co-investment opportunities. Some negotiate for contractual rights to co-investments. Others merely ask to be place in a pool of availability with no specific promises of opportunities.

Ultimately, it’s a contractual right negotiated between the fund manager and the investor. Clearly, the fund manager needs to live up to its contractual obligations with its investors. Failing to do so is an area appropriate for SEC intervention.

Sources:

Vertical Integration of Fund Manager and Related Party Expenses

Marc Wyatt had been on the job for 16 days as the Acting Director Office of Compliance Inspections and Examinations when he took his first shots at private fund managers. He took a shot directly at real estate fund managers and indirectly at other types of fund managers with vertical integration.

13979480708_a190d97982_z

The Speech

While we found that sometimes these ancillary services are indeed not disclosed, a more frequent observation was that investors have allowed the manager to charge these additional fees based on the understanding that the fees would be at or below a market rate. Unfortunately, we rarely saw that the vertically integrated manager was able to substantiate claims that such fees are “at market or lower.”

In-House Counsel

I particularly noted that Mr. Wyatt included charges for a fund’s in-house attorneys as part of vertical integration. It’s tucked into the real estate advisers portion of the speech, but I’ve seen fund managers in many industries charge in-house lawyers’ time to funds and portfolio companies.

There is nothing inherently wrong with charging this expense, provided it is disclosed to investors. If it’s not disclosed, the explanation is that the services are being provided at less expense than if the fund manager engaged outside counsel.

Mr. Wyatt raises the concern that fund managers are not documenting the cost savings. If a fund manager is claiming that the expense is “at market or lower” the manager needs to be able to prove it.

For in-house counsel, that may be as easy as documenting the costs when using outside counsel and comparing rates.

Property Management, Construction Management and Leasing Agents

The specific concern in Mr. Wyatt’s speech was for real estate fund managers that have their own property management, construction or leasing divisions. Again, there is nothing inherently wrong with this integration and charging the expenses as long as it is disclosed to investors.

If the fund manager is claiming that it is charging these expenses “at market or lower”, the fund manager needs to prove this statement is true. The SEC exam team will be looking for good benchmarks to substantiate the claims. Anecdotal evidence will not suffice.

Sources:

Boston Skyline is by Dennis Forgione
CC BY SA

What Are the Implications of the SEC’s New Private Fund Exam Unit

SEC Seal 2

Greg Roumeliotis and Sarah N. Lynch are reporting in Reuters that the Securities and Exchange Commission has formed a new group dedicated to the exam of private equity and hedge funds. This new private fund unit will be co-chaired by Igor Rozenblit and Marc Wyatt. Rozenblit is coming from the asset management unit of the SEC’s enforcement division and is a former private equity professional. Wyatt joined the SEC in 2012 as a private funds examiner and formerly worked for hedge funds.

Based on the private fund managers I have spoken with that have been subject to a SEC exam, nearly all have found that the examiners knew little about private equity, real estate, or more exotic hedge funds. Examiners’ knowledge seems mostly limited to retail investment advisers, mutual fund advisers, and basic hedge funds.

I assume the new unit will be largely focused on education. I’ve heard Rozenblit speak and he certainly understands how private equity works and where enforcement should focus. I think he will offer great insight for examiners.

Assuming this story is true, I expect there will be significant changes to the exam process for private fund managers. The document request letters have often been a poor fit for private equity funds. Some even show a complete misunderstanding of how a private equity fund operates. That leads to lots of time wasted by examiners and fund managers subject to examination.

References: