Even four years on from Dodd-Frank pushing most of the industry under the SEC’s spotlight in 2012, private fund managers still have plenty of questions about what it takes to clear the exam process. The SEC has developed a deeper understanding of the industry’s workings, leading to more nuanced, targeted exams.
So in light of clients’ compliance challenges, Navatar teamed up with the Association for Corporate Growth, a mid-market trade body that helps private fund managers monitor emerging regulatory issues, and took the conversation to a SEC funds examiner for more perspective as part of a roundtable discussion.
Watch and read transcript: “The SEC Staff Answers Your Burning Questions on Examinations.”
Five of our clients’ exam-related questions stood out to us in particular. Below, we paraphrase responses from Maryellen Maurer, a SEC funds examiner:
1. Can a CCO wear multiple hats?
Large firms have the resources to hire dedicated compliance chiefs. That’s less true for smaller outfits, who often double the CFO as CCO. Is that a problem? No, so long as the person juggling multiple roles can handle it. But often dual hatted CCOs spend less than 50 percent of their time on compliance, Maryellen warned during the roundtable. That can lead to problems if the CCO only pays lip service to compliance. Maryellen said these CCOs can discuss in detail trading rules, a familiar area for CFOs, but struggle to apply the same specificity to other compliance areas. Meanwhile CCOs that understand all the firm’s processes, and don’t need to schedule many meeting to answer follow-up questions, provide examiners assurance.
2. Are fees still an issue?
Funds pay for costs related to the fund, the firm picks up everything else. GPs (and their lawyers) know this, but things blur when you get into the weeds. Maryellen provided an example of a fund manager charging cybersecurity insurance to the fund. Which is normally fine. But an issue arose when it was discovered the insurance policy also protected firm employees from lost data, something arguably the management firm itself should pay for. And this is where fees still become a problem. Maryellen said managers often walk back fee-related claims during follow-up questioning, perhaps because they are not giving individual charges and expenses enough thought.
3. Are my valuations safe?
The good news is that valuation practices “have definitely become better” in terms of documentation and consistency, said Maryellen. But now the bad news: valuation summary pages are still light. “LPs should be able to review the valuation methodology used for portfolio companies and clearly understand it in detail,” Maryellen said, a goal some GPs fall short of. Another ongoing concern is a “hands off” approach taken by some CCOs to the valuation process. Maryellen said compliance personnel should not only understand the valuation process, but valuation testing as well. CCOs should understand why transaction multiples changed from one quarter to the next, for instance, and challenge it when necessary.
4. How worried should I be about business continuity planning?
In June, the SEC floated a proposal asking firms to implement response plans for natural disasters, terrorism or loss of key personnel, raising concerns that business continuity planning would become the next SEC focus area. If so, should CCOs be worried? It seems the proposal is primarily intended to formalize a set of expectations already embedded in accompanying rules. Maryellen said the proposal’s intent is to provide more “specificity about what is needed” compared to the current compliance program rule that discusses business continuity planning at a high-level. But to assure regulators that business continuity planning is being taken seriously, investment advisors are pumping additional resources in preparing for the worst. Indeed, the one-two punch of Hurricanes Sandy and Katrina warned Wall St. firms of the danger of putting all their computers in the same place. Here the cloud is winning support, as running software independently of a physical server is increasingly seen as a necessary safeguard.
5. Do slow SEC response times indicate trouble?
You’re near the exam finish line, and all the SEC’s requested documents have been sent. But after weeks of no response, panic sets in. Did the SEC find something wrong? Is enforcement action looming? Rest assure response times are dictated by any number of things, including limited administrative staff at the commission to process paperwork. Once the SEC is offsite, “we may contact you right away to ask more questions…or it may be a few weeks before we do that,” said Maryellen. In other words, trying to gauge when your SEC exam results come in is futile – a message LPs should hear if they happen to be aware of the exam and enquire about it.
There were plenty more burning exam questions addressed. But we encourage industry participants to watch or read the recording in full. At a time when compliance is a bigger challenge for small and big firms alike, it’s important to hear from regulators themselves about their take on compliance matters.
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