Financial Services Regulatory Practice How we can help private equity advisors. September 2010

Transcription

1 How we can help private equity advisors September 2010

2 Contents Section Page Introduction 2 1 Key private equity challenges 3 2 Compliance risks 4 3 Potential conflicts: dealings between portfolio companies 8 4 Regulatory themes 9 5 Our team 11 6 Our approach 12 7 Client needs and service offerings 13 8 Our thought leadership 16 9 Team members Contact list 31 1

3 Introduction Financial regulatory reforms passed in July 2010 will require most private equity ( PE ) fund advisors to register with the US Securities and Exchange Commission ( SEC ). After being exempt from registration for over 70 years, PE advisors will now be subject to the full scope of the Investment Advisers Act of 1940 ( Advisers Act ), increased disclosure and reporting requirements, and periodic inspections by the SEC. Importantly, because Congress left critical details for rulemaking by regulatory agencies, this adjustment will be a multi-year process. The registration requirement poses challenges for PE advisors. They will need to identify conflicts that may cause advisors to render investment advice that is not disinterested in violation of their fiduciary duty to clients and investors. Advisors will need to either eliminate or disclose and control such conflicts in a way that satisfies not only investors who are demanding ever-increasing levels of transparency, but also regulators that have increased their focus on alternative asset managers, ramping-up enforcement actions against managers of hedge and PE funds. The next few years are likely to be especially difficult because the new registration requirement also poses challenges for the SEC and other regulators, who may less familiar with the PE business model and its conflicts. These potential conflicts involving fee arrangements, counterparties, co-investments, underwriters, portfolio companies, leverage providers, placement agents, etc. - are vastly different from the staid world of registered mutual funds and institutional separate account managers where regulators have deep experience. PE advisors will need to carefully manage relationships with regulators during this adjustment period and show a compliance-focused approach that may diminish regulators' concerns regarding essentially a new industry for which they are now responsible. The consequences of non-compliance with the regulators' requirements and expectations are regularly in the news even as key stakeholders (investors, boards of directors, portfolio companies, counterparties, etc.) are also increasingly questioning the effectiveness of existing compliance and governance programs. PE advisors should seize this opportunity to assess their operations, policies and procedures in light of the Advisers Act requirements and the regulators' increasingly aggressive approach. They should ensure that their governance and control frameworks are designed and operate to prevent significant breaches of their fiduciary duty and assure meaningful disclosure to investors and sound compliance practices. Careful attention to compliance and governance issues will be a distinguishing factor of leaders in the private-equity field in the current challenging market, regulatory and fund-raising environment. 2

4 Key private equity challenges Oversight of portfolio companies Portfolio companies dealings with foreign jurisdictions Fiduciary duties to other investors in portfolio companies Assignment of investment adviser employees as officers/directors of portfolio companies Inter-dealings among portfolio companies Conflicts around selection of underwriters to take portfolio companies public Implementation or enhancement of compliance program and control environment Appointment of a Chief Compliance Officer Adoption and implementation of policies and procedures Required annual review of internal policies and procedures Designing a compliance program and control environment that is consistent with what has been represented to investors in offering memos, DDQ s, pitch books, etc. Information barriers between private and public sides Establishment of strong information barriers between the private and public sides of the investment adviser Design and implementation of policies and procedures for wall crossings including appropriate monitoring efforts Consideration of immediate and extended impact of possessing material non-public information ( MNPI ) e.g. potential restrictions in trading securities of a particular issuer 3

5 Compliance risks Top compliance risk areas for private equity advisors Compliance program Safeguarding investor assets Valuation Does your firm have a tailored Compliance Program to identify and assess risks specific to a PE setting? Do you periodically monitor your compliance with the Advisers Act as well as evaluate your overall control environment so that it is operating effectively? Can the level of such monitoring be demonstrated to regulators and investors? Is the compliance program and control environment designed to ensure that all aspects of the business are operating in a manner that is consistent with what has been represented to investors? Does your firm maintain custody of your privately held securities in accordance with the SEC s revised custody rules? Are management fees becoming more of a profit centre rather than a means to cover normal operating costs? Should fees be charged if the fund is not doing any new deals? As carried interest declines or is delayed, are controls in place to ensure that legitimate managementcompany expenses are not charged to the fund? If the general partner ( GP ) is going public, are its long-term investment interests still aligned with limited partners, or is the GP s time an attention now focused on capitalizing carried interest? Are assets from subsequent fund series being used to support investment positions in previous series? Are related diligence fees charged only to funds/accounts that ultimately participate in new deals, including all co-investors? Has the firm adopted formal, written pricing and fair valuation policies and procedures? How are these administered and enforced? How does your firm gain comfort that internally modelled illiquid securities are valued appropriately? Does your firm utilize a third party valuation agent to value your illiquid positions? 4

6 Compliance risks Top compliance risk areas for private equity advisors Valuation (continued) Institutional conflicts How active is secondary trading in LP interests of the fund, and what implications does this have for the firm s pricing policy? When determining performance track records for purposes of marketing a subsequent PE fund, how are remaining positions in the previous fund(s) valued? How are all potential and real institutional conflicts with limited partners, affiliates, counterparties, and other service providers identified and controlled? What are the formal, documented procedures for allocating scarce private-equity opportunities amongst all the firm s funds and clients that are eligible? How do the procedures ensure that funds with significant ownership by management are not advantaged? If the fund participates-in or offers co-investments on PE deals, how are all of the potential conflicts identified and controlled? What has been disclosed regarding receipt and benefit of deal-related fees (break-up fees, consulting fees, exit fees, director fees, portfolio company management fees, etc.)? How does the GP know if it is compliance with this disclosure? Does the adviser have any pressure to invest committed capital before a deadline? If so, how does the adviser ensure that full, quality due diligence is performed on each investment made near the deadline? What controls are in place to ensure that any conflicts between funds or accounts that own different parts of the capital structure of the same issuer (i.e. bank debt, senior debt, mezzanine funding, equity, convertibles, etc.) are disclosed and managed? What controls are in place to monitor and handle potential conflicts between the fund and other portfolio company investors - for example, increasing portfolio company debt in order to pay a special dividend to the PE fund and other equity holders? 5

7 Compliance risks Top compliance risk areas for private equity advisors Personal conflicts Insider trading Does your firm have a written Code of Ethics that addresses personal investments, surveillance procedures, gifts and entertainment, proper usage, nepotism, and other risk areas? Do your principals or your employees have direct ownership in the portfolio companies owned by your funds? Can employees who make investment recommendations co-invest along-side funds? Do they personally receive management, director or consulting fees? Do they personally invest in fund-of funds that invest-in or co-invest with the adviser s funds? Can employees invest in PE deals that are considered but ultimately not purchased by the adviser s funds or accounts? How is this conflict resolved? Has the adviser surveyed its officers and employees to ensure that there are no business dealings or market transactions between the adviser, the funds, and any close family member? Has your firm adopted an insider trading policy? Has the firm thought out of the box to identify all possible sources of MNPI related to a PE setting (other than clear cases of entering confidentiality agreements, etc). Has your firm implemented procedures to prevent and detect possible insider trading? Are employees fully trained to know where the lines are regarding MNPI? Do any of your investment professionals have ties to other asset advisers, either financially or personally? How much contact is there between the adviser s front-officer personnel and other hedge-fund or privateequity firms? What consideration has been given to individual limited partners in the adviser s funds who, as officers and directors of public companies, could be potential sources of MNPI? Does the firm have a well controlled policy for the approval and use of outside consulting firms that offer research and diligence services? What are the adviser s controls around information walls, restricted lists and watch lists? How are they monitored and enforced? 6

8 Compliance risks Top compliance risk areas for private equity advisors Investment guidelines and restrictions Marketing practices Regulatory reporting Market manipulation Risk disclosures Does your firm s strategy and investment follow representations made in the offering documents and marketing materials? How do you ensure that investments are made in accordance with guidelines and restrictions (e.g. style drift, industry, issuer or geography concentration limits, risk measures, leverage limits, etc)? Does your firm clearly and accurately represent its performance metrics to current and prospective investors? Does your firm maintain all the required supporting documentation for historical performance disclosures? Has the adviser fully vetted all conflicts associated with the use of outside solicitors or third-party marketers? Do you have solid pay-to-play policies and procedures around soliciting state/municipal investors that meet the SEC s new rules in this area? Does your firm delegate responsibilities of regulatory filings and is that firm or employee aware of their responsibilities? Has management audited the firm s filings for completeness and accuracy (13D, 13G, 13F, Form SH, Forms 3,4 and 5, Form ADV, portfolio company filings, blue-sky filings, etc). Could the advisor be accused of not fully complying with these disclosure requirements in order to cover-up its true intent towards a portfolio company? Is there a set of procedures in place to ensure accuracy and consistency of disclosures in your Form ADV? Does your firm have policies and procedures to address rumours and other market manipulation issues? Can employees confidently distinguish between rumours and potential insider information? What policies are in place regarding communications, meetings or other joint business activity with other buy-side firms? With portfolio companies or targets? Are appropriate disclosures made to the investors regarding the types of risk that may be present in a PE strategy? Does your firm have a disclosure committee or other group that monitors offering documents, prospectuses, and marketing materials for accuracy, completeness, and consistency? Does your risk management process address investment, market, and counterparty risks as well as other risks relevant to the PE space? 7

9 Potential conflicts: dealings between portfolio companies Forced synergies Contingent funding Use of adviser employees as officers and directors of portfolio companies PC 1 PC 1 Registered investment advisor Registered investment advisor employees Registered investment advisor RIA owns 35% RIA owns 100% CFO, CIO Director Management consultant PC 2 PC 1 PC 1 PC 1 PC 2 PC 3 PC 1 Potential conflicts 1. The RIA will influence through the use of board seats, contingent funding and resources to the Portfolio Companies to only if they contract goods solely from one another. 8 Potential conflicts 1. Will the RIA only provide additional funding to PC 1 if PC1 only purchases certain goods /materials or services from PC2? 2. Board obligation to the other investors in PC # 1 are inter-pc deals arms-length? Potential conflicts 1. Adviser temporarily places nonqualified personnel within PCs in order to shift costs

10 Regulatory themes Regulatory interfaces Enforcement: civil and criminal Transparency with advisory clients and fund investors Governance and compliance Organizational complexities Examinations: routine, cause, sweep Regulatory filings: e.g., Forms ADV, Regulation SHO, Section 13 SEC Financial Crimes Enforcement Network (FinCEN), US Department of Treasury Department of Labor IRS FBI and US Attorneys State Attorneys General State Securities authorities Disclosure Investment strategies/risk guidelines and adherence to them Custody of funds Conflicts of interest Board and senior management review and approvals Policies and procedures Training Controls Documentation Surveillance, testing and follow-up Interaction with affiliates Mergers and acquisitions New products, locations and strategies Resource changes 9

11 Regulatory themes Globalization Integration and intersection of investment adviser and brokerdealer industries New enforcement and inspection approaches Interaction with Financial Supervisory Commission (FSC) Hong Kong Interaction with Financial Services Authority (FSA) London Interaction with China Securities Regulatory Commission (CSRC) China Joint registrants Custody of assets Conflicts of interest Distribution and capital raising Information barriers Valuation Operational support Counterparty exposure Resources Training/expertise Technology Data analysis New protocols Specialization: - Investment management including PE funds - Market abuses insider trading and market manipulation - Municipal securities pay to play - Foreign Corrupt Practices Act 10

12 Our team can help address regulatory compliance issues and manage regulatory risk effectively. Our asset management regulatory team, a part of the firm s national financial services regulatory practice, is comprised of experienced professionals with diverse backgrounds in the asset management industry. Our team includes: Former director and an associate director of the SEC s Office of Compliance Inspections and Examinations Former associate director of the New York office of the SEC Former SEC examiners and branch chiefs Former chief compliance officers Forensics and investigations experts Data and systems specialists 11

13 Our approach Risk & controls focused Identify and rank areas of risk, and map controls in place to mitigate risks in order to identify potential gaps or misallocations of resources Experienced professionals Knowledge and experience to identify issues and provide practical solutions Your firm Issue driven Up-to-the minute information about current and emerging regulatory issues Technology based Forensic & data analysis capabilities Partnering with governance, risk & compliance system providers to offer compliance and control automation 12

14 Client needs and service offerings Needs PwC services PwC solutions/client benefit Assistance required with the annual review of compliance policies, procedures and controls Desire to understand leading industry practices Desire to understand the current focus areas of the SEC A registered investment adviser is subject to inspection by the SEC Assistance is needed to assess its readiness for inspection An unregistered investment adviser is preparing to register, and once registered, will be subject to inspection by the SEC A newly-registered adviser needs assistance drafting compliance policies and procedures Compliance review for registered or unregistered fund and/or adviser Assess the client s current compliance risks through a series of interviews Review the client s documents, including compliance policies and procedures and investor disclosure documents (i.e. offering documents, investor letters) Perform sample testing of the procedures performed Make recommendations on the client s controls, policies and procedures based on our assessment and review and provide information on leading industry practices Mock exam Perform a mock SEC inspection Provide the client with our assessment and recommendations for improvement as well as aspects of the compliance program that might draw attention from the SEC Registration readiness: Assisting organizations in migrating from an unregistered operating environment to a registered operating environment Developing and/or assessing compliance policies and procedures Assist the client in designing a compliance program that addresses regulatory requirements and is tailored to the specific compliance risks at the firm -- based on regulatory requirements and industry leading practices Provide the client with an assessment and recommendations for improvements, as well as aspects of the compliance program that, once registered, might draw attention from the SEC Assess the client s operational environment through interviews and reviews of investor documents Work with the compliance staff to draft integrated policies and procedures that embody the specific operational and compliance requirements of the client 13

15 Client needs and service offerings Needs PwC services PwC solutions/client benefit The SEC is currently inspecting the investment adviser The adviser needs assistance with meeting inspection requests and interview preparation Indication of a possible compliance breach that warrants further investigation The Board or Audit Committee has mandated that the compliance department perform a full review of the fund or adviser s governance structures, including committee charters and key oversight controls An internal investigation or a regulatory enforcement action requires that firm refund amounts owed or to pay disgorgement and civil penalties to investors The SEC or another regulator has instituted an enforcement action requiring the firm to hire an Independent Compliance Consultant as part of a remediation program A registered adviser would like to measure their compliance program against those of their peers Regulatory inspection support Assist clients in assessing and organizing documentation to be provided to the SEC and in understanding the regulatory process Discuss any potential violations with top management Identify possible improvements to address deficiencies Special investigations Perform a special review of the problem Assist the client in developing an integrated control solution that addresses the root causes of the problem Reviews of fund governance and controls as mandated by Board or Audit Committee Assist the client by assessing the governance frameworks Recommend appropriate and practical improvements Special investigations Assist the client with calculating and processing the distribution amounts Appointment as Independent Compliance Consultant Benchmarking of compliance programs against leading industry practices Fulfill the requirements of the Independent Compliance Consultant Assist with implementing a remediation program Assist the client in drafting and submitting any required assessment report to SEC or other regulatory authority Perform benchmarking and gap analyses of the adviser s compliance program against programs of similarly structured advisers and also against leading industry practices 14

16 Client needs and service offerings Needs PwC services PwC solutions/client benefit A company is in the process of acquiring an advisory firm or a portfolio company The acquiring firm needs a full operational assessment of the target firm, including an assessment of the firm s compliance program A US registered adviser has branch offices in London, Dubai, New Delhi, and Hong Kong (or other global locations). The CCO needs assistance integrating the satellite offices into the adviser s compliance network A registered fund adviser employs staff who understand securities law but lack experience in applying Advisers Act regulatory requirements to the operations of their enterprise Participating in merger and acquisition due diligence and on integration teams Assisting organizations establish global compliance and control standards Assess and review the compliance program of the target firm Provide a risk-rated assessment of the compliance program to the acquiring firm When the transaction closes, liaise between the two compliance departments and assist with the integration of compliance department systems, personnel, policies and procedures Assess the client s current global compliance program Assist the client in developing a compliance control framework tailored to each of the adviser s satellite offices Assist the client in creating a reporting mechanism for each of the branches to communicate with the US office Training of compliance staff Develop and administer a compliance training class for the adviser s staff using expertise in adviser compliance objectives, operations, internal audit and testing Provide special training on new regulatory requirements and implementation 15

17 Our thought leadership PwC's regulatory professionals take great pride in being recognized as thought leaders in the industry. Some of our recent, noteworthy regulatory publications include: 16

18 Team members Thomas A. Biolsi, Principal, New York Telephone: Tom Biolsi is a principal in PwC s and has 30 years of industry experience. He is a subject matter expert on regulatory issues and serves PwC's financial services industry clients helping asset managers in identifying, assessing, and controlling business, operational, and compliance risk. Tom recently rejoined PwC after serving three years in the New York Regional Office of the Securities and Exchange Commission as Associate Regional Director. At the SEC, Tom was responsible for the Investment Management Inspection Program in New York, overseeing more than 2,000 registrants with over $10 trillion in assets under management. Tom also participated in programs for foreign regulators in Asia, Europe and Central America. Prior to serving as the Associate Regional Director at the SEC, Tom served as a managing director in PwC s Regulatory Consulting Practice for 10 years. He developed a mock SEC audit inspection program and numerous other initiatives related to developing protocols and risk controls for the asset management industry. His expertise is frequently requested from law firms on behalf of asset management firms and from regulators. Tom also worked for seven years as a Chief Compliance Officer for a global asset management organization. Tom is also a frequent speaker at numerous industry, regulatory, and academic related compliance conferences. Lori Richards, Principal, Washington, DC/New York Telephone: lori.richards@us.pwc.com Lori Richards is a principal with. Lori is the former Director of the SEC s inspection and examination program, the Office of Compliance Inspections and Examinations (OCIE). As the first Director of OCIE, she built and led the SEC s nationwide examination oversight program for broker-dealers, investment advisers, investment companies, hedge funds, transfer agents, clearing agencies, trading markets and self-regulatory organizations for 14 years. Prior to that, she served as Associate Regional Director for Enforcement in the SEC s Los Angeles office. She has been at the forefront of securities regulatory compliance. Lori received numerous honors and awards for distinguished service at the SEC. She is also a frequent industry speaker and author of numerous articles on compliance, fraud and fiduciary responsibility. Lori has a JD from American University and a BA from Northern Illinois University. 17

19 Team members Robert Nisi, Managing Director, San Francisco Telephone: Rob Nisi leads PwC's West Coast. As a Managing Director in the practice, he has more than 20 years of investment management and compliance experience. Rob began his investment management career in 1988 as a senior staff attorney with the Division of Investment Management and Enforcement in the SEC's New York Regional Office. After the SEC, he continued his investment management with the law firms of Kramer Levin and White & Case, and later was Assistant General Counsel to Prudential Insurance Company and Salomon Smith Barney. In 1998, he joined MacKay Shields where he was Senior Managing Director and General Counsel. From 2005 through 2008, Rob helped launch and run the business operations of a start-up hedge fund as the Chief Operating Officer, General Counsel, and Head of Corporate Risk Management. Anjali Kamat, Director, New York Telephone: anjali.kamat@us.pwc.com Anjali Kamat has over 15 years of professional experience and has managed and participated in various regulatory projects conducted for institutional money management firms and alternative asset managers. Her experience covers a broad range of engagements including, mock" SEC reviews, policy and procedure drafting, internal control assessments, trading analyses, internal investigations, merger integration, performance composite reviews, and assisting firms in facilitating SEC inspections. Apart from working with registered investment advisers, Anjali has assisted un-registered advisers, particularly hedge fund managers, prepare for registration with the SEC. Prior to joining PwC, Anjali worked as a senior examiner in the US Securities and Exchange Commission's Northeast Regional Office based out of New York. While at the SEC, she conducted numerous compliance inspections of registered investment advisers, some of which were referred to enforcement. 18

20 Team members Kent Knudson, Director, Washington, DC/New York Telephone: Kent Knudson is a director in PwC s and been a member of the team since He has worked on many engagements for domestic and foreign asset managers including mock SEC exams, implementation of automated compliance systems, internal investigations, regulatory enforcement proceedings, and M&A due diligence. For the past three years, Kent has focused primarily on alternative asset managers and hedge funds, assisting in drafting compliance procedures and conducting conflict reviews. Kent recently led a team conducting an IPO-allocation investigation mandated by the SEC. Kent also serves as a senior instructor in PwC's Professional Development Program providing client training and education. Prior to joining PwC, Kent worked for eight years at SEC headquarters in Washington, first as an examiner and then as a branch chief in the Office of Compliance Inspections and Examinations where he focused on mutual funds and investment advisers. While at the SEC, Kent played key roles in overseeing and writing reports on soft dollars (1998) and fair valuation of foreign securities (1997). Kent also participated in the first foreign exams of US registered advisers and the first reviews of fixed-income pricing services. Kent was the primary headquarters liaison for the SEC's Chicago and L.A. offices. Scott Pomfret, Director, Boston Telephone: scott.pomfret@us.pwc.com Scott Pomfret is a director in the. He has led engagements that included a mock SEC exam of a $140b mutual and hedge fund complex and a Rule 38a-1 policy and procedure review for a major global financial services company. Prior to joining PwC, Scott spent six-years at the Boston Regional Office of the Securities and Exchange Commission, where he was a Branch Chief in the Division of Enforcement. In that role, Scott led enforcement and examination teams investigating a wide range of traditional and alternative asset managers and issues, including mutual fund market timing, insider trading, and misrepresentations concerning assets under management, performance, and risk management. Scott has collaborated on investigations with the regulators at the CFTC, Federal Energy Regulatory Commission, Department of Labor, FBI, Department of Justice, and numerous state securities regulators. He was a member of the SEC s Hedge Fund Working Group, won an Enforcement Division Director s Award in both 2007 and 2008, and was named an Up and Coming Lawyer by Massachusetts Lawyers Weekly in Prior to joining the SEC, Scott was a litigation associate for five years at Ropes & Gray LLP, where his practice focused on responding to regulators in government enforcement matters. 19

21 Contact list Name Title Office Phone Number Address Tom Biolsi Principal New York Lori Richards Principal Washington, DC/New York Robert Nisi Managing Director San Francisco Anjali Kamat Director New York Kent Knudson Director Washington, DC/New York Scott Pomfret Director Boston

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