Tag: Private fund

The One with Fund Custody Footfault

ECM had investment advisory clients and managed two private funds in which some of its advisory clients invested. Based on the SEC order it looks like ECM tripped over the complexities of the Custody Rule in managing the investments.

An investment adviser has custody of client assets if it holds, directly or indirectly, client funds or securities, or if it has the ability to obtain possession of those funds or securities. Under the custody rule, an investment adviser who has custody has four main obligations:

  1. ensure that a qualified custodian maintains the clients assets;
  2. notify the client in writing of accounts opened by the adviser on the client’s behalf,
  3. have a reasonable basis for believing that the qualified custodian sends account statements at least quarterly to clients, and
  4. ensure that client funds and securities are verified by actual examination each year by an independent public accountant in a surprise exam.

A private fund can comply with obligations 2, 3, and 4 by having the fund audited annually and sending the audited financial statements to the fund investors with 120 days of the fiscal year of the private fund.

You don’t have to comply with custody requirement of 1 for “privately offered securities.” Those are private placements that are uncertificated and can’t be transferred without consent of the issuer. Think limited partnerships and private funds.

One problem was with what the order called “paper memberships” in the private fund. I was a bit confused by what was going on. I think the problem was that ECM was holding on to the limited partnership agreements signed by its clients who invested in the private funds.

The privately offered securities exception is only for obligation 1 of custody. You still have to comply with obligation 4 of custody and have a surprise examination.

Of course that is if you have custody. I think the problem is solved by having the partnership agreements send to the clients so you don’t have custody.

It looks like ECM also failed to have the private funds audited.

Of course this may all change when (or if) the SEC enacts the proposed Safeguarding Rule.

Sources:

Strategies for marrying ESG implementation and compliance – at the Private Fund Compliance Forum 2018

Investors have increased their focus on Environmental, Social and Governance issues. This panel focused on the compliance role in ESG.

According to a poll at the conference, about half of the attendees have a written ESG policy and consider ESG as part of their strategy. There is the balance between wanting to invest for good and to invest for returns. There is a larger push to just block investments in particular areas such as tobacco, pornography, arms manufacturers, etc.

Investors are specifically asking for a written ESG policy. The policies have a great deal of discretion. Investors often do not have specific requirements for the substance of the ESG policy. Investors want to know that you are thinking about these issues.

Fund limited partners are reporting their ESG goals, or at least those issues they are most interested in, as part of their reporting. So they are expecting their funds to report on these issues. The challenge is that investors are asking a wide range of questions on a wide range of issues. It’s a challenge to gather the disparate data and put together quantitative numbers.

The #MeToo issue is a current hot topic. Fund managers are pushing down to their portfolio companies to implement ESG policies, as well as implementing them at the fund manager.

Compliance can help by doing what compliance does: drafting policies, implementing procedures to effectuate the policy, and track the data in the implementation.

There are many ways to approach ESG, pick one and try it out if you haven’t yet. Get someone in senior management to sponsor the effort. It’s not just about being a treehugger, it’s about creating value in your portfolio companies and value in your fund management.

(This session was subject to the Chatham House Rule so I have not identified the participants and have not attributed any of the statements to anyone.)