Maintaining records

Scott Pomfret of PricewaterhouseCoopers discuss how to best create and maintain books and records for compliance programmes.

A general counsel at a private equity firm complained about the prospect of registration with the Securities and Exchange Commission (SEC). “We are constantly on the lookout to make sure we are doing right by the investors in our funds,” he said. “We meet constantly, we weigh competing options and we act for their benefit. The problem is… we don’t document it!”

One of the biggest cultural shifts registration demands of advisers to private equity funds is the requirement that for the first time they will be required to document many aspects of their business and maintain that documentation in an easily accessible place so that it can be provided when the regulator comes knocking. This chapter will address the books and records advisers to private equity firms are required to create and maintain; how long, where and in what form the books and records must be maintained; what books and records are not required but are advisable to create and maintain; and setting up a process for creating, maintaining and ultimately destructing the records.

Rule 204-2 issued by the SEC pursuant to the Investment Advisers Act of 1940 (the ‘Advisers Act’) sets forth 17 categories of books and records an investment adviser must maintain to the extent they relate to its advisory business. In broad strokes, such books and records include:

(i) corporate records;
(ii) financial records;
(iii) compliance records;
(iv) marketing records;
(v) client records;
(vi) portfolio management records; and
(vii) proxy voting records.

Not all the requirements have a perfect analogue to private equity funds; several seem designed to advisers whose business involves actively trading securities. Table 6.1 summarizes the categories required of books and records.

Although for private equity firms, many of the required books and records in categories 1 to 5 are similar to those required of other investment advisers, certain records kept by private equity fund advisers are likely to differ from those kept by other fund advisers. For example, as private equity advisers do not actively trade securities, portfolio management records (for example, order memoranda) do not exist and, of course, private equity funds likely may not be holding and voting proxies for public companies, except possibly where the fund retains a stake post-initial public offering or participates in a PIPE (private investment in public equity) transaction.

However, although advisers to private equity firms do not enter orders for the purchase of publicly traded securities, they need to create and maintain certain portfolio management records such as:

• research files (including due diligence files);
• records of transactions between the funds managed by the same adviser; and
• copies of confidentiality agreements.

Perhaps the most important of the required records is the Form ADV, which consists of two parts. Part 1 is filed with the SEC and publicly available online. It contains information about the adviser, including business, affiliations and assets under management.

Part 2 discloses more detailed information about the adviser, its potential conflicts, its business practices and the background of its key executive officers. In the past, the adviser provided ADV Part 2 to investors to comply with the SEC’s ‘Brochure Rule,’ but Part 2 was not filed with the SEC. However, new rules require Part 2 to be filed and it will also be available on the SEC’s public website. SEC examiners closely scrutinize the information in Part 2 during inspections.

An area of frequent lapses for private equity advisers is the failure to create written policies and procedures to document their ongoing business practices and operations.

Advisers that maintain custody of client securities or funds must make and keep, among others, records showing all purchases, sales, receipts and deliveries of securities and all other debits and credits to such accounts. Note that the books and records of a private fund are deemed to be books and records of the private fund’s adviser where the adviser or any related person acts as the private fund’s general partner, managing member or similar capacity.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the ‘Dodd-Frank Act’) empowers the SEC to impose additional requirements for advisers to private funds (including private equity funds) that are necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk by the Financial Stability Oversight Council established by the Dodd-Frank Act.

Additional records set forth in the Dodd-Frank Act include records relating to:
• Amount of assets under management and use of leverage, including off-balance sheets;
• Counterparty credit risk exposure;
• Trading and investment positions;
• Valuation policies and practices;
• Types of assets held;
• Side arrangements or side letters;
• Trading practices; and
• Other information ‘necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.’

While many of these documents are called for under existing requirements the SEC will engage in a rulemaking process to define the new requirements which may cast a wider net than current regulations. Moreover, the rulemaking process may require periodic reports to the SEC on the same topics for which these documents likely form the basis.

This partial chapter is one of 24 in The US Private Equity Fund Compliance Guide: How to register and maintain an active and effective compliance program under the Investment Advisers Act of 1940, a new book from PEI Media.