In a column late this summer I prodded buyout shops to take a stronger stand against proposed legislation requiring them to register as investments advisers with the Securities and Exchange Commission. This time I thought I’d take the more practical tack of providing advice on how to get prepared—just in case.
The Obama Administration, as well as several members of Congress, have separately introduced bills that would compel most private investment funds—buyout funds, venture capital funds, funds of funds, hedge funds, CLO funds—to register as investment advisers under the Investment Advisers Act of 1940.
Outside of opposition from the National Venture Capital Association, and my lonely column, the proposals haven’t generated much controversy. Assuming the legislation passes, one of the first questions facing buyout shops would be how long they have to prepare.
According to Robert Bagnall, counsel at law firm WilmerHale, the timetable depends on whether the law requires the SEC to develop fresh rules governing registration, or whether it skips that step and simply requires firms to register automatically. Under the first, more laid-back scenario, the SEC would typically take six to nine months for rulemaking, then provide for, say, another six-month transition period for firms to come into compliance, Bagnall said. By contrast, a law skipping the rulemaking step might provide for a single six to nine month transition period to come into compliance.
Bagnall offered this insight last month at an online seminar, “PE/VC Firms: Registration And The New Regulatory Regime,” hosted by Thomson Reuters, publisher of Buyouts. He was joined by fellow compliance experts Barry P. Schwartz, a partner at ACA Compliance Group, a consulting firm; and Timothy R.M. Bryant, partner and chief compliance officer at
* During the transition period, it’s important to review the history of your firm and its management for any prior disciplinary action taken by the SEC, or related legal actions. The SEC can use such events to justify denying registration to your firm, or limiting its activities.
* Expect to spend at least a couple of hundred thousand dollars a year to maintain a compliance program.
* Keep an eye on new rules governing registered investment advisers recently proposed by the SEC. For example, in the wake of the Madoff scandal, the SEC has proposed tightening up its custody rule to require all assets managed by an adviser to be held by an independent custodian.
* Pay special attention to rules governing conflicts of interest. These can quickly add up for buyout firms with several core funds actively investing at the same time, not to mention annex funds, add-on funds and side-pocket funds set up for select investors. Buyout pros also often have opportunities to co-invest in select deals. At a minimum, all conflicts would need to be disclosed to the SEC.
* Your need to retain books and records ratchets up mightily once in the clutches of the Investment Advisers Act of 1940. You’ll not only have to retain emails, instant messages and text messages, but store them in an organized way that allows easy access and retrieval. You may want to strongly consider prohibiting employees from using social networking sites such as LinkedIn for business communications; if not, you will have to retain and store messages sent through those sites as well.
* It’s a good idea, though not an SEC requirement, to provide ongoing education to employees about their obligations while working for a registered investment adviser. One effective method is to take employees through common situations they may face—finding themselves in possession of material, non-public information, say—and show them how to handle them appropriately.
* During your first examination by the SEC, expect to spend extra time educating the examiners about the industry, what you do, how your firm is structured. This may well be the first time the examiners have dealt with a buyout shop. Don’t be surprised to get a deficiency letter in the wake of the exam that finds flaws in your compliance program and asks for corrective action. That happens in more than 90 percent of routine SEC examinations, according to Schwartz.
* Don’t expect much, if any, advance notice on SEC examinations, perhaps a week or two. In fact, it’s a great idea to conduct mock exams to be ready. Many exams last between one and six months but don’t be surprised for it to stretch to a year or more. In the past, how frequently advisers are subject to examinations has depended in part on what risk bucket the SEC places them in after conducting a short, initial review called a “get-to-know-you” exam. Depending on their risk profiles, advisers have found themselves subject to exams as frequently as every one to two years, or as infrequently as every seven to 10 years or more, according to Schwartz. However, the SEC is re-evaluating how it goes about conducting its examinations in the wake of the Madoff scandal.
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