The private equity industry is facing a number of regulatory changes, in the US and beyond, that will change the scope of how GPs manage their firms. Just last month, the US Securities and Exchange Commission finalised SEC registration rules, making registration a reality for most private equity firms. Managers will face regular inspections by the SEC, must designate a compliance officer, and explicitly outline how to deal with potential conflicts of interest, among other requirements.
On a recent June afternoon in New York, PE Manager sat down with five veterans of the private equity market to discuss SEC registration and other compliance challenges, and to compare notes on what managers can do weather upcoming compliance storms.
SEC registration was very much on the minds of our roundtablers. As chance would have it, PEM’s roundtable participants met the day after the SEC finalized rules 22 June and formally extended the registration deadline to 30 March, 2012, a delay that most of the roundtable participants will take advantage of.
“I don’t think anyone was surprised by the news. For us, it isn’t that significant since we’re on track to register,” said Paula Bosco, chief compliance officer of New Mountain Capital. “We are currently working to have the advisor to our private equity funds registered, but we have all the infrastructure in place.”
Gabrielle Preiser, compliance manager with Bessemer Venture Partners said the firm has yet to register and the delay is welcome news. “The delay is beneficial. It will give firms that need to register more time to evaluate the final rules and to “operationalise” their compliance.”
While the delay has been granted, it doesn’t change the challenges that must be met. Among the many changes that registration brings, perhaps the most anticipated revolve around creating a culture of compliance. Panellists agreed that the marketing and compliance functions must work together more closely than ever.
“I think as an ongoing matter, once you are registered, the culture of compliance part is very important,” said Jon Zagrodzky, chief administrative officer and chief compliance officer for Oak Hill Capital Partners.
And a culture of compliance is not just the look and feel at a firm, but it’s the documentation firms put in place. “It’s important to document regularly over time what you are doing and how you address different topics,” said Zagrodzky. “There should always be something going on in terms of compliance, whether it’s following up on a compliance-related question, holding a training session or just communicating recent compliance news items. Regular and consistent attention to compliance, which you should carefully document, is not only a good thing to show the SEC, but it also helps build awareness at the firm.”
Bosco agreed: “You have to build a culture of compliance and it really starts at the top,” she said. “A lot of it has to do it with trust and that takes time to build.”
It helps to have continuous conversations with senior management, not from a lecturing perspective, but an education perspective. “I take the point of view that ‘I’m here to help you. My job is to give you info, what you do with the information is up to you, but I’m going to give you that information’,” said Bosco.
Consistency is also key when creating a compliance culture, said Bosco. “You don’t want to have one set of rules for senior management and a separate set of rules for other employees.”
ESTABLISHING PROCEDURES
Becoming registered would bring many changes in the way private equity firms establish and implement policies and procedures.
Several panellists stated that it’s almost worse to have a policy that is not operational than no policy at all. “If you’re going to have a policy, make sure you have well-developed procedures that accounting or HR or anyone whose work might have compliance-related components can follow,” said Zagrodzky.
A lot of that can be accomplished through effective communication. “I found it helpful to spend time with these folks to check their procedures and ensure that the information they track and record can be easily summarised and reviewed,” said Zagrodzky. “Once you do this, you can be more confident that your team is making the right compliance-related decisions and recording the right information each and every day.”
James Gaven, senior compliance counsel at Welsh, Carson, Anderson & Stowe, agreed that communication is crucial. “We’re developing our policies now—one way to create that culture of compliance is to get people’s input on what their everyday tasks entail and get their ideas on ways to incorporate those into the procedures,” said Gaven.
Training sessions are also effective in creating a culture of compliance. “Whenever we have training, we make it mandatory and have sign in sheets that show attendance, including attendance from the most senior people in the firm,” said Bosco. “It’s important for other employees to see that.”
When it comes to implementing policies, it’s important to make sure your policy is broad, but that procedures are more detailed.
“The policies a firm develops, and the procedures that are adopted to manage these policies, must be consistent with your firm culture and work effectively together,” said Preiser. “For example, we're creating a due diligence framework and checklist we can use to uncover FCPA risks for prospective portfolio companies operating internationally. For it to work, such a checklist must be usable. You want it to be brief so investment professionals and portfolio companies embrace it, but you need it sufficiently detailed for us to implement our policy-that is, help flag material risks. There's a balance to be struck, I think, in terms of how granular your procedures need to be.”
Procedures are key when there’s an infraction at the firm. “You do the best training you can, but if something falls through the cracks, you aggressively follow up,” said Zagrodzky. “You tailor your response to the nature of the violation and you carefully document what you did and why. Once this is done, you should ask what you can do to minimise the chances of a future failing. Do we need to clarify or strengthen our policies or procedures? Should we increase or improve training? Have we done enough to build awareness?”
Policies need to reflect the steps the firm took to address the problem. “If you operate in a way that is reflected in polices and documents, great, but if you operate in a way that isn’t square with your procedures, that’s going to be point number one in the examiner’s report,” said Julie Corelli, a partner with Pepper Hamilton.
The discussion turned to panellists offering advice to those that are not as far along in the registration process. “The best thing to do is to get help,” said Zagrodzky. “Make sure you work with a third party that is experienced with preparing required documents, but also experienced in the coaching you need to establish internal procedures as well as the beginnings of a culture of compliance. It also helps to get senior leadership on board with compliance. If it’s important to the CEO or managing partner, it will be important to everyone in the organisation.”
“If someone is going through it now, make sure you communicate why you’re implementing a new policy or procedure,” said Gaven. “It will make it much easier to get everyone on the same page. Senior management buy-in is very important. Our senior management is actively involved in ensuring that we put an effective programme in place.”
“Even if you are not yet registered, you likely should have been operating this way for a long time, what’s changed is that you now have to document and be able to show a regulator that you’re operating this way,” said Corelli. “Of course, advisors have always been and will continue to be subject to anti-fraud rule regardless of whether they are registered.”
“You should have been operating this way for a long time, what’s changed is that you now have to show that you’re operating this way,” said Corelli. “Clients have always been subject to anti-fraud rule.”
Assessing resources is something panelists spent a long time discussing. “I hear about adding compliance resources a lot. ‘We’re a small firm how do we fit this into our budget? Can we make this an investor expense?’ The answer is no, you can’t,” said Corelli. “You go through a learning curve on how to address the questions of who and how much is the cost. It’s important to find a person inside that can say no to the CEO and someone that knows the rules. “
Bosco agreed that outside help could be useful for some firms. “In the beginning you might want to bring in an outside consultant to help you understand the lay of the land. They can help you develop your risk matrix; help you understand your business from a compliance perspective.”
Indeed, private equity firms need to have a set of documents on day one of SEC registration—a compliance programme, manual, risk assessment procedures and a map of controls the firm has in place.
While outside consultants can prove helpful, nothing beats having a dedicated compliance team in-house. “You could get help from the outside, but at the end of the day they leave and you’re left with a compliance manual,” said Bosco. “It becomes more important to have dedicated compliance professionals in place as your firm grows.”
INVESTOR RELATIONS
The way in which private equity firms communicate to investors has changed in light of pending regulations. Panellists agreed that compliance is more of an expectation than something that’s formally presented to investors.
“We’ve had one or two LPs ask about our progress with registration, but we do anticipate it being a bigger part of the due diligence process going forward,” said Gaven. “Once private equity sponsors register, LPs will be able to make an apples-toapples comparison. We anticipate that this is something investors will look at and you will have to demonstrate that you have a good programme in place. “
Bosco agreed: “We have not had many requests to see the actual compliance manual. When an investor is represented by a third party, the third party has asked to see it. I usually allow them to see a hard copy and look at it on site, but can’t take it out of the building. If they have additional questions after the review, they could set up a meeting or call to discuss further.”
However, at Oak Hill, “we don’t get many requests, but there is a passive expectation out there that you should have a robust and effective compliance programme, even if no one is asking about it,” said Zagrodzky. “Having such a programme not only helps ensure compliance with important laws and regulations, but it’s also the right and moral thing to do.”
From a legal standpoint, it’s rare for institutional limited partners to ask to see a compliance manual. “They will ask whether you are registered, need to be registered, if you intend to register, but generally don’t ask to see the compliance manual,” said Corelli.
Pepper Hamilton advises on what LPs want to know. “Investors often want to know that advisors have at least a code of ethics and policies about documentation and document retention, and how they do background checks on people who lead portfolio companies,” said Corelli.
The way in which marketing materials are presented has changed dramatically which leads to the compliance and investor relations teams working closer than ever. “When ILPA 1 came out, it focused on transparency and a lot of people expected that a whole cottage industry of IR would develop,” said Corelli. “The cry for greater transparency has in fact generated a lot of overlap between investor relations and compliance, so much more than they used to. There’s more demand for information so that means there’s more controls over information and the more there are controls the more there is demand. It’s a cycle of information flow going through a strong filter. It helps with transparency but makes the advisor’s compliance officer’s job much harder.”
EUROPEAN REGULATIONS
It’s easy to solely focus on US trends and regulations as the roundtable met in New York, but panelists were mindful of regulatory activity across the pond.
“Being based in New York, we focus on SEC rules, but it’s also important to be able to track international regulations that can have an impact on your business,” said Gaven. “Most of us are pretty attuned to what’s going on in the US, but there are a lot of international regulatory issues out there you want to proactively address in order to facilitate business for your firm in overseas jurisdictions.”
“We’ve been focused on the UK Bribery Act,” said Bosco.
Indeed, the UK Bribery Act, which came into force 1 July, mandates firms with operations in the UK to put in place “adequate procedures” to prevent situations of bribery. Guidance has described six principles courts should adopt in determining an adequate anti-bribery policy. The principles advised firms to implement compliance procedures proportionate to the bribery risk they faced through their activities. It further called for firms to implement due diligence programs and periodically undergo bribery risk assessment initiatives.
Moreover senior executives should foster a culture of integrity, for instance by communicating its anti-bribery policies or training staff on compliance.
The act brings UK policy more in line with the US Foreign Corrupt Practices Act (FCPA). Following the financial crisis, the US ramped up investigations of companies under the act.
Managers are eying rules and regulations outside the UK as well. “There will be more rules around fundraising and that’s something we follow closely,” said Gaven. “For instance, the
UAE and Kuwait have recently proposed or passed regulations as to how you can market your funds. It’s something on our radar since we want to cultivate a global base of LPs. “
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