It is clear that, with the signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the regulatory regime governing private equity fund managers will change dramatically.
For the first time, registration for most advisors will be mandatory, as will new record-keeping requirements and compulsory disclosure of certain financial and operational information.
Advisors to private equity funds with more than $100 million in assets under management will be required to register with the SEC and be subject to SEC regulatory oversight unless they qualify for one of the express exemptions. Exemptions exist for venture capital funds and family offices, with a definition of venture capital funds to be provided by the SEC within a year of enactment, and for advisors solely to private funds with less than $150 million in assets under management.
Even if exempt from registration, advisors to private funds with less than $150 million assets under management and venture capital funds will be subject to record-keeping and reporting requirements to be established by the SEC and inspection of their records by the SEC.
Additionally, regulatory changes not specifically directed at hedge funds, private equity funds, other asset managers and investment advisors — including provisions regarding swaps and other derivatives and asset-backed securities — will nevertheless have a substantial impact on these organizations.
Not only will these changes have a material impact on operational and compliance requirements and processes — for example, firms will need to develop rigorous processes for the creation and maintenance of documentation — they also portend an increase in document requests, “sweep reviews” and examinations and inspections by the SEC. In light of the broad reach of the legislation, we have highlighted areas that firms should take into consideration.
Those required to register will have to do so by 21 July 2011, unless the SEC extends the deadline. One result of registration is the requirement to comply with the following rules:
• Designate a chief compliance officer
• Establish and maintain a compliance program, including the adoption and implementation of written policies and procedures reasonably designed to prevent violations of law and regulatory requirements
• Annually assess the adequacy of the compliance program
Reporting and record-keeping requirements
The SEC will adopt rules that require each registered private fund advisor, as well as unregistered advisors to venture capital funds and private funds with less than $150 million assets under management, to maintain records and file reports about certain information relating to each private fund it advises, to assist in the assessment of systemic risk, including:
• Assets under management
• Information on the use of leverage
• Counterparty credit risk exposure
• Trading and investment positions
• Valuation policies and practices
• Types of assets held
• Side arrangements or side letters
• Trading practices
The new requirements under Dodd-Frank will not be effective immediately, giving firms the opportunity to review and upgrade their current practices, particularly with respect to operations, technology and compliance functions, to implement new systems and processes and to prepare for registration and subsequent regulatory review. We recommend a proactive approach: build compliance infrastructure now to avoid complications down the road upon SEC investigation.
Immediate action steps should include designating a chief compliance officer, updating compliance manuals and processes to be current and sensitive to SEC focus areas, and performing tests or mock examinations of the compliance program to identify possible improper activities. In addition, training of staff should begin on the new policies and procedures.
Below is a list of some of the activities investment advisors should be focused on in light of the new legislation:
• Compliance governance structure
• Identifying and naming a chief compliance officer
• Developing and implementing compliance policies and procedures
• Establishing monitoring, surveillance and testing programs
• Preparing for SEC registration and reporting requirements
• Identifying key compliance risks and evaluating mitigating controls
• Comparing current record-keeping practices to what is required by the regulators
Arthur Tully is a partner and co-leader of the global hedge fund practice of Ernst & Young, Nancy Reich is an executive director in the Financial Services Office, and Daniel New is senior manager in the National Asset Management Advisory Practice of Ernst & Young.