The SEC’s new private fund rules may make a casualty of the multi-hatted CCO.
“Looking at the rules economically, the smaller and mid-size firms are now wondering whether their CFOs can still be the firm’s CCO,” says Joseph Morrissey, a partner with Seward & Kissel. “There’s been some talk about how there’s just too much of a compliance burden now to have a dual-hatted compliance position and some of the smaller firms are wondering whether it’s time to split the roles.”
Nearly three-fifths of registered private fund advisers tack compliance onto their executives’ other duties, an analysis of Form ADV data by affiliate title RCW finds. The new rules, adopted by a divided Commission Aug. 23, are massive and complex. Some of their restrictions apply to exempt advisers, who are not even required to hire a CCO. For registered funds, there are 16 categories of expenses that will have to be calculated and distributed quarterly.
“No doubt this will add to the workload of the CFO, the CCO, and their outside counsel,” says David Momborquette, a partner with McDermott, Will & Emery. “This should’ve been clear through the years but it’s an issue we revisit every couple of years – how important it is for the CCO to be integrated into the day-to-day work of the firm.”
Fund advisers have long been doing more with less. In July, the IAA and compliance consulting firms ACA Group and Yuter Compliance Consulting published their 18th annual investment adviser survey. They found that a majority of firms (nearly half of which advised private funds) spent $500,000 or less on compliance.
‘Tone from the top’
That may not be enough any more – and may not have been all along. The SEC cannot require firms to separate compliance from other departments. But regulators have made clear they want to see “a culture of compliance” woven into the fabric of the firms they examine. “We continue to believe,” regulators said in their 2021 exam priorities, “it is important to emphasize that compliance programs, CCOs and other compliance staff play critically important roles at firms. Indeed, culture and tone from the top are key.”
Over the years, regulators added, they have noticed a few “hallmarks” for a good compliance program. “One such hallmark includes compliance’s active engagement in most facets of firm operations and early involvement in important business developments, such as product innovation and new services. Another is a knowledgeable and empowered CCOs with full responsibility, authority and resources to develop and enforce policies and procedures of the firm.”
‘The business end of things’
At a minimum, firms will have to think of new and better ways of integrating compliance into their day-to-day business, Momborquette says.
“What are the terms of side letters? Who do we have them with? You never should’ve been but you really can’t any longer be reactive, off to the side,” he says. “You can’t wait for some report to kick out to tell you there may have been a cross-trade that might be a problem for you. If you’re not on top of the business end of things, and who’s doing what, and what agreements you have with investors, what are the terms, and what are some of the transactions that could run afoul of the secondaries rules, you could have a real problem.”
The conversations are already starting. One CCO/CFO at a mid-sized private equity firm said there is simply too much compliance work to do now, even if the firm uses outside compliance consultants. The SEC cannot mandate standalone compliance departments, but the burdens of new rules may make it inevitable, the CCO/CFO said.