Private Fund Compliance Forum 2013

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.

Impact of Foreign Regulations on Private Equity Firms Doing Business Abroad

PEI PFC Forum 2013

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

James V. Gaven, Senior Compliance Counsel,Welsh, Carson, Anderson & Stowe
Alan K. Halfenger, Chief Compliance Officer, Bain Capital LLC
Greg Pusch, SVP, Director of Global Regulatory Compliance & CCO, HarbourVest Partners, LLC

The US loaded up funds with the new regulatory framework imposed by Dodd-Frank. Foreign jurisdictions have also imposed tough new regulations.

There is a July deadline for dealing with the AIFMD in the EU that imposes restrictions on private placements.

EU is a mess. The regulations are not in place, so you can’t register yet and don’t know exactly what you need to do to register. It’s going to be a county by country analysis, requiring county by country registration.

You will also need to specifically address how advice is given and where the investment decisions are being made. You need to focus on the granting of discretionary decision making.

It’s not just the EU, other countries have restrictions on marketing within the country to investors in the country.

The EU AIFMD comes into full force in 2018. There is a political overlay that may affect things. There is a lot of uncertainty. The UK has not created the application form yet to apply for private placement clearance.

Know Your Customer and AML procedures become important when marketing to overseas investors. You don’t want “bad guys” as investors. Foreign investors will be a red flag for examiners. It’s okay to use a risk-based approach to investor diligence. The standard is disclosure of significant ownership, ranging from 10% to 25% of the ownership.

The Middle East is a problem. Their regulations make it very difficult to market in Saudi Arabia. Korea has some tough regulations affecting private fund marketing.

You need to be concerned about placement agents from the perspective of FCPA and supervision. You need to audit periodically about any changes they are making to the marketing materials.

There is some thought about setting up parallel funds for EU investors. However, the EU regs tie back to the main fund and still requires registration.

Successfully managing the resources of your office

PEI PFC Forum 2013

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

Jason E. Brown, Partner, Ropes & Gray LLP
Reuben B. Ackerman, Chief Compliance Officer, Berkshire Partners LLC
Terry E. Everett, Chief Financial Officer & Chief Compliance Officer, Rockland Capital, LLC
Daniel H. Weintraub, Managing Director & General Counsel, Audax Group

The CCO should not be the sole person in the firm responsible for compliance. It requires all employees to care and all managers to take responsibility.

Engage accounting. They see the flow of cash, employee expenses, political contributions and entertainment expenses. They would also be on the frontline for money laundering risks.

The investor relations team should see it as an extension of their role. Investors want to see compliance and see it as necessary for their investment choices.

Put a candy bowl in your office, it’s a great way to lure employees in with questions.

Technology tools are important to improve productivity.

Email surveillance? It’s not required by SEC rules, but it seems to always come up in SEC audits. Use keywords. You will need to deal with lots of false positives.

Personal securities trading is difficult. Employees will want that information to be limited to one or a very few people. You should not disclose that information to other employees. You need to be concerned about the privacy concerns.

Should all employees be access employees? You need to have access to non-public information and need to be a supervised person. All employees are supervised persons. Most likely you do not have effective barriers to prevent employees from getting non-public information. For example, an administrative assistant may see a memo about an upcoming transaction.

When thinking about pushing the boundaries of SEC rules think about the disclosure to investors when they ask about a deficiency letter.

Should you monitor personal email accounts on third party email platforms like gmail, or yahoo mail. Have them certify that they do not use personal email accounts for work email.

Conducting your annual review to ensure compliance

PEI PFC Forum 2013

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

Brian Kawakami, Partner, Ascendant Compliance Management
Charles Lerner, Principal, Fiduciary Compliance Associates LLC, and Editor, The US Private Equity
Fund Compliance Guide and The US Private Equity Fund Compliance Companion
Jim O’Connor, Chief Compliance Officer, Golden Gate Capital

Rule 206(4)-7 specifically requires an annual review of the compliance program. The release identifies 10 points for review.

What is annually? There is no clear requirement. It is fine to have it run during a time that people are available. End of year can be a bad time. April 15 is a bad time.

The Commission has stated that it expects your policies and procedures, at a minimum, to address the following issues to the extent that they are relevant to your business and therefore would expect them to be included in the annual review:

Portfolio management processes, including allocation of investment opportunities among clients and consistency of portfolios with clients’ investment objectives, your disclosures to clients, and applicable regulatory restrictions;
The accuracy of disclosures made to investors, clients, and regulators, including account statements and advertisements;
Proprietary trading by you and the personal trading activities of your supervised persons;
Safeguarding of client assets from conversion or inappropriate use by your personnel;
The accurate creation of required records and their maintenance in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction;
Safeguards for the privacy protection of client records and information;
Trading practices, including procedures by which you satisfy your best execution obligation, use client brokerage to obtain research and other services (referred to as “soft dollar arrangements”), and allocate aggregated trades among clients;
Marketing advisory services, including the use of solicitors;
Processes to value client holdings and assess fees based on those valuations; and
Business continuity plans.

Valuation is at the top of the list for private equity. You want consistency and you want adherence to the policies.

Charles recommended that you have the annual review include an outside person. It’s hard to review yourself. (He added a self-promotion disclaimer.)

There was a disagreement about the use of outside parties in the annual review. A gap analysis can be protected by attorney-client privilege. A written annual review cannot.

How do you show “tone at the top”? It’s key to have senior management in compliance training. It’s good to have a regular meetings between heads of the firm and the CCO. The CCO should regularly send out regular compliance remainders.

Conflict analysis should include allocation of expenses. Are expenses being reasonable allocated to the funds and to the manager.

A warning sign of a problem is people who are unwilling to offer up the requested information.

Charles shared a story over the use of the company plane. From a compliance standpoint you should review the flight log to make sure the plane went to business locations and not to personal travel. One SEC examiner raised an issue that the plane should be subject to competitive bidding.

An annual review should look closely at co-investments and compare to the policy and procedures. Make sure the selection of co-investment meets the procedures. You should not base that choice solely on the basis of the size of an investor’s interest in the fund. You don’t just want to have the biggest if others want to invest.

The SEC will want to know how you make money. How you make money will lead a path to business operations and conflicts.

Charles recommended that you don’t rely just on the personal trading software platform to identify red flags. It’s good to grab the statements and see the holdings more holistically.

Part of the annual review should include a risk matrix so you can produce something in response to enterprise risk management. Presence exams are, in part, focused on high risks. Plot how the risks are relevant to your firm and rate them.