I’m attending the PERE CFOs & CCOs Forum. These are my notes from the session.
Bruce Karpati interviewed Igor Rozenblit, Co-head of the Private Fund Unit at OCIE, Securities and Exchange Commission. Of course, Igor’s views are his own and do not necessarily reflect the views of the SEC or the Commissioners.
Prior, when Bruce was at the SEC he interviewed Igor and hired him to join the SEC.
Igor’s group audits industry participants. A different group is responsible for making regulations and the enforcement unit is responsible for enforcement. Igor helps to train examiners so they know the difference between property management and fund management.
Real estate is a small portion of the SEC’s oversight. Hedge funds and private equity funds and managers are more numerous than real estate. They see more complexity and more conflicts with real estate managers.
They just completed a real estate initiatives focused on value-add and opportunity funds. It is still continuing. Some of the concerns.
Undisclosed related party vendors is the first. He mentioned spinoffs of managers units and then having the manager engage that unit as a fund expense.
Partially disclosed is next. The manager discloses the relationship, but not the full scope of expenses.
Market-rate. He has not had an exam where the market rate was supported. They have found managers with counter-support. The manager charges less to third-parties than to the fund. He offered no specific way to prove market rate to the satisfaction of the SEC. His recommendation was third-party market surveys.
Chargebacks should have three components. First is clarity about what is charged to the fund. The SEC views ambiguity against the fund manager. The default should be to the benefit of the investor.
In-house legal expenses charged to the fund are a noted problem. The fund documents typically provide for the fund pay legal expenses, but the manager to pay for personnel expenses. Igor’s position is that the in-house legal should be a manager expense unless explicitly provided in the fund documents.
The second is comprehesiveness of disclosure. It needs to be broader than just to the Advisory Board.
The third is timeliness. Disclosure after the fund closes is insufficient.
Valuation is a key focus. Real estate is the classic hard to value asset. The SEC is looking for a good process and not a single person controlling the valuation. Lots of review and approval is good in the eyes of the SEC.
One evolving area is fund managers controlling assets moving from fund to fund for distressed debt. It intertwines the manager on both sides of the transaction and has a valuation issue.
There are 500 SEC examiners focused on asset management. There is a variation among regions and among the different examiners. Igor’s Unit plays a key role in targeting managers for examination.
Onsite will vary depending on location and complexity. Typically it lasts a week. Then it continues back in the office with SEC likely asking follow-up questions and asking for more documents.
To prepare for an exam, Igor thinks you take a holistic approach and identify risks ahead of time. Make sure you are aware of them and are dealing with them.
Intangibles during the exam are key. Do not be combative. Be likable. Do not try to hide something, DO not look like you are trying to hide things.
He does not think the speed of document production is key, accuracy is more important.
Looking for fraud is what they do. The exam can turn investigative if the examiners finds problems.
How to avoid enforcement? Stealing money gets you in enforcement. Units may be looking to send a message to the industry and can use enforcement to do so.
Igor expects the CCO will quarterback the exam and the CFO will have a big role addressing the finance function.
There are few options for fixing SEC discovered conflicts in closed funds. One solution is approval of the advisory board if the fund documents allow the board to approve conflicts. Otherwise it requires changes to fund documents.
Igor noted that the Investment Advisors Act’s anti-fraud provisions have applied to fund managers regardless if they are registered. It’s just the post-Dodd-Frank registration that has given the SEC the ability to exam registered real estate fund managers and given the SEC more insight into the industry.
The use of joint ventures is a point of focus for the SEC. The SEC is concerned about potential conflicts in the relationship. IN particular if senior management of the fund manager has other business relationships with the joint venture partner.
Igor has found that outsourced compliance is not doing the robust job the SEC expects. He noted an outsourced CCO who did so for several dozen firms. Of course, the expense needs to be determined as to whether it is a fund expense or a manager expense.
Make sure you are treating your investors fairly.
Even a sophisticated investor can not detect that it is being charged more than bargained for if the investor does not have access to the information.
Why is valuation important when fund managers are not paid on unrealized gain. One is the use of higher valuations in marketing. The second is in taking a deal-by-deal promote based on the higher valuation.
Cyber risk is important for real estate fund managers. Don’t let hackers get at your stuff.