It was Pam Hendrickson, a past recipient of the PE Manager Leadership Award, who put out the call:
“Join us. Be a part of the conversation. Speak to regulators about the challenges we as an industry are facing. It’s easy to say we don’t have a voice in these matters, but we do.”
Hendrickson was speaking before some 400 or so of her peers at the PEI CFOs and COOs Forum earlier this year in New York. While best known for her day job as chief operating officer of mid-market private equity firm The Riverside Company, Hendrickson issued the invitation in her capacity as chairman of the Association for Corporation Growth (ACG), an organization dedicated to the needs of mid-market private equity professionals, investment bankers, and business leaders.
At the conference, Hendrickson said that ACG representatives would be meeting with SEC officials a few days later. Her goal was to bring other COOs, CFOs and CCOs into the conversation. A few delegates went on to answer her call.
There was a subtext to Hendrickson’s on-stage message: SEC officials are mindful that some of the regulations under the Investment Advisers Act were really written with other types of investment advisors in mind and as such, are an imperfect fit for the private equity model.
On the sidelines of the conference, PE Manager was later told by several delegates in attendance that Hendrickson’s words served as a useful reminder that the SEC is not an adversary – it’s a regulator still learning about how to supervise an industry that it’s only had proper oversight of for a mere two years.
ACG’s working group, which is headed by Richard Jaffe, co-head of law firm Duane Morris’ private equity practice, and Scott Gluck of law firm Venable (along with a few mid-market private equity fund managers who volunteered from the conference) went on to meet with SEC officials a day before the agency held its national compliance outreach seminar in late January.
What this shows, first and foremost, is that the agency appears open to the idea of having regular conversations with the ACG’s SEC working group about its relationship with the industry. (Editor’s note: those interested in joining this group can email ACG manager of policy communications Amber Landis at email@example.com).
At the closed-door January meeting, PEM has exclusively learned that the working group brought to the SEC’s attention a number of compliance concerns, on which GPs are eager for greater guidance. On the agenda specifically was:
1. General Solicitation
One issue discussed was general solicitation, on which the SEC lifted the ban late last year. For the most part, fund managers have declined to take advantage of their new freedom to market funds, largely because they’re still unsure about what compliance steps must be taken before hitting the public airwaves. For some, those concerns are being validated during SEC inspections. The ACG working group shared experiences of GPs who were told during exams that listing a fund’s portfolio companies on the firm’s website could constitute a general solicitation. Ditto for firms that share information on past fund vehicles, or include testimonials from past portfolio executives about their relationship with the GP.
The working group at the meeting explained that private equity websites are not designed with investors in mind; they’re more of a way to reach potential portfolio executives, entrepreneurs and investment banks with businesses to sell. In other words, the website is rarely used a tool to reach a wider investor audience, the group said.
Also in the meeting, recordkeeping requirements under the IAA were discussed, particularly those involving personal trading records. The private equity industry, which largely deals in illiquid long-term investments, feels that tracking the personal trading activity of every “access person” – which at some firms includes every employee of the fund – is an expensive, bureaucratic exercise that does little to reduce insider trading. There’s a feeling that regulators looked at the massive trading activity of hedge funds and assumed it must make sense for all alternative assets to be covered by the rule. What the industry would like to do is compromise on a middle ground, mindful that inspectors would like some protections in place against private equity insider trading.
GPs are also required to preserve emails and other communications related to fund business. The working group told the SEC that some compliance officers felt the regulations were overly broad – particularly with respect to personal emails. Often CCOs would be required to review highly personal messages from employees, and the working group expressed a desire to get a reasonable limitation on the email retention requirements.
3. Custody requirements
Not surprisingly, the SEC’s custody rule was another point of discussion. The industry gripes that paying banks tens of thousands of dollars to hold private stock certificates – which if lost or stolen could not be utilized for sinister purposes – is a waste of money. Following those complaints, the agency provided GPs some welcome relief on custody requirements last August when it clarified that the rule does not necessarily cover private stock certificates issued in a private placement. In the guidance, the agency said it “would not object” if a GP maintained its private stock certificates or partnership agreements internally, provided that the fund was subject to a financial statement audit (as most GPs are); that transfer of the security could only take place with LP consent; and that the stock certificate could be replaced upon loss or destruction (along with some other technical criteria).
The ACG working group praised the additional guidance, but said the criterion requiring a private stock certificate to contain certain language restricting its transfer meant that many private equity firms have been unable to take advantage of the relief. Likewise, the requirement that firms use GAAP accounting is preventing some Small Business Investment Company (SBIC) – legal structures that often use the US Small Business Administration’s accounting standards – from getting custody rule relief.
Next on the agenda was Form PF and Form ADV reporting, which regulators use to monitor systemic risk and the universe of investment advisers under their watch. The working group noted that the definition of a “hedge fund” used for SEC reporting was overly broad, and might inadvertently capture firms that would be better represented as private equity in the government’s records. However in updated guidance released late February, the SEC preserved its definition of a hedge fund for purposes of Form PF reporting.
During the latter half of the meeting, the working group met with the head of and other top staff from the SEC’s Office of Compliance Inspections and Examinations (OCIE) to discuss a broad range of issues relating to examinations of private equity funds. The issue of SEC examiners’ review of valuations was a key topic of discussion. It is understood that SEC staff said that they are not trying to second-guess audits, but rather to check that any changes in a firm’s valuation policies and procedures were being clearly communicated to investors before the changes were reflected in performance reporting.
A final topic discussed was how firms allocate expenses between the management company and investors; again, the industry said more guidance was needed here.
“Everyone agreed that this was a very productive meeting,” said Scott Gluck, one of the leaders of ACG’s working group. “We all found SEC staff to be attentive, generous with their time and genuinely concerned about the needs of middle-market private equity. We look forward to continuing the dialogue with the SEC.”