This article is sponsored by CSC.
There’s no shortage of questions surrounding the US Securities and Exchange Commission’s new Private Fund Adviser Rules, but one certainty is the high cost and considerable effort required to reach this new compliance threshold. The SEC has estimated that producing the new quarterly statements along with performance reports would cost the industry about $500 million each year. Overall compliance for the industry is estimated close to $1 billion, according to the Financial Times.
The regulations themselves offer little clarity on deciding priorities. For some pointers, we spoke with Anne Anquillare, the head of CSC’s US Fund Solutions business, and her colleague, Chris Patton, who leads the firm’s Fund Solutions business in the UK, Channel Islands and Spain.
Given the scope of the SEC’s new PFA regs, what’s the best way for a manager to start complying?
Anne Anquillare: The first thing that a manager should do is consult with their counsel and compliance staff to discern if they’re covered by the rules, and if so, which rules are applicable to them. If the manager is an ordinary middle market buyout firm in the US registered with the SEC, they’re covered by all the rules. For managers of real estate funds and foreign managers, the determination is more nuanced.
With foreign managers, it’s good to take a step back and consider the SEC’s actual jurisdiction. The SEC has jurisdiction over the adviser’s relationship with the fund, while the investors are clients of the fund. Oddly enough, the SEC doesn’t have jurisdiction over the relationship between the advisers and their funds’ investors. It can step in and regulate with regards to the fund, but with investors, the SEC’s influence is diluted.
Chris Patton: The position for foreign fund managers/advisers and sub-advisers can be complex, and I agree with Anne that they should seek advice to ensure they get ready to comply with whichever rules apply to them. A non-US adviser, registered with the SEC as an investment adviser, advising one or more onshore US funds, will have to meet all the requirements of the new rules. However, non-US advisers, who are not registered with the SEC (including Exempt Reporting Advisers, foreign private advisers and other non-registered investment advisers), only need to comply with the restricted activities and preferential treatment rules in relation to onshore US funds they advise.
Non-US advisers who are registered with the SEC (including those who do not advise US onshore funds) will be required to assess the sufficiency of their compliance policies and procedures, annually and in writing, in accordance with the compliance rule.
AA: Also, when preparing to comply with the new rules, bear in mind that the annual review of compliance policies and procedures is there to help the examination process. In a way, it’s a requirement to self-confess. Should the SEC examiner find that the manager’s review missed a gap in compliance, they might get concerned about the culture of compliance at the firm.
Let’s take that US mid-market firm that’s registered with the SEC. What’s the next step in the compliance effort?
AA: It’s got to be looking at the quarterly statement rule, given the workload involved. This could require an overhaul of the firm’s entire accounting system or at least a change to the fund’s chart of accounts, because of the granular detail that’s now required. The way accounting systems work is a user can always combine data in transactions or accounts, but the user can’t split data without a lot of manual intervention. The system needs to be upgraded and the data needs to be split to capture this new granular detail, because manually producing these reports in the 45-day period invites real trouble.
Also, the best way to distribute the quarterly reports is through an investor portal. It reduces the cost of delivery, is more secure than email and provides the evidence required to demonstrate delivery within the applicable period under the rule. Firms should investigate their current investor portal capabilities to confirm it is up to the task.
CP: It’s also a matter of training staff on these new bookkeeping processes and training the checkers to do so with the correct detail, codes and narratives. Otherwise, the final report will not include the granularity of data required by the rules, and that’s where an exam from the SEC would go off the rails.
Checkers need to sign off on activities at least monthly, so that by quarter’s end, all the cash transactions are booked accurately. And then, for us, all we’re waiting for are period-end adjustments and valuations from the client. Some clients may struggle with delivering those valuations on time without changing their processes, which will require planning with and educating deal teams.
AA: The back office is naturally compliance minded, but the front office might not appreciate the benefits of a culture of compliance (yet). There could be some training and education to be done on that front.
What’s interesting here is that the challenges will differ according to the type of fund. Take a private debt fund, there’ll be an enormous amount of activity to review and cleanse. With a traditional buyout vehicle, the valuations might prove the hardest to complete in a timely manner. The one thing likely to be true of any manager is that assembling that quarterly report will be a scramble without careful forward planning. I’d strongly advise a trial run using data for December 31, 2024, or even September 30, 2024.
The last priority here must be around fees and expenses, which also bulk up that quarterly statement.
AA: There will be so much more volume and detail around tracking fees and expenses. One of the core themes is that there is no materiality. Nothing can be logged in a “miscellaneous” category. Like the rest of the quarterly statement data, it needs to be broken out into new, more specific categories, which will require changes to the accounting system, and how the managers and bookkeepers are trained.
Managers can’t forget that even if they report fees and expenses just as the SEC would like them to, every fee and expense must be matched to the correct section of the LPA or other governing documents. Overall, I think this should be seen as an evolution, where we close the gap between what is standard industry practice and what the SEC requires.
CP: A lot of managers might already have this level of detail on hand, even if they’re not sharing it with LPs. Some might already report this information to avoid individual information requests during the year. These rule changes may result in more commonality in reporting from managers globally. That’s certainly a good thing for the industry’s efficiency, and for investors.