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Employee Conflicts of Interest NA Regulations

What Should Private Funds Do About New SEC Disclosure Rules?

The SEC is making a move into the private fund investment space. Here are the details and thoughts on how affected firms—like private equity funds and hedge funds—can efficiently and effectively manage it all

On February 9, the Securities and Exchange Commission voted to formally propose expanded reporting requirements for private investment funds, such as private equity funds and hedge funds. If approved, for the first time private funds would be required to disclose to their investors such basic information as fund performance, fees, and expenses. It would also require registered private fund advisers to obtain an annual audit for each private fund, distribute a fairness opinion to investors, and prohibit all private fund advisers—even unregistered ones—from engaging in “certain activities and practices that are contrary to the public interest and the protection of investors.” Finally, it would prohibit said advisers “from providing certain types of preferential treatment that have a material negative effect on other investors.” In other words, any activity that might create conflicts of interest.

The preliminary vote was three to one in favor of the rule. Final adoption isn’t guaranteed, but such a vote count indicates adoption is likely. The rule proposal went into a minimum two-month public comment period upon its announcement, but at the time this blog was going to press there was no further word on it. Why now, one might ask, is the SEC bearing down on the heretofore largely left-alone world of private investment funds? Size, in a word. Per the SEC, the private fund marketplace is an $18 trillion one. “Private fund advisers, through the funds they manage, touch so much of our economy,” said SEC Chairman Gary Gensler. Democratic SEC Commissioner Allison Lee chimed in along similar lines: “When [private investment funds] are big firms, they can have a huge impact on thousands of people’s lives with absolutely no visibility for investors, employees and their unions, regulators, or the public.”

Whatever the reasoning, this seems to be happening, which leaves private equity firms and hedge funds in the position of having to think about mitigating conflicts in a way they‘ve never had to before. This isn’t to imply that they didn’t think about conflicts of interest at all before. It’s in the best interest of any investment fund to ensure it operates conflict free. But once something is codified—whether by fiat-regulation or legislation—there’s less room for error. Firms have to be more precise in how they handle potential conflicts. And the stakes are raised. “Now the government can come in, tell you that you did something wrong, and fine or sanction you for it—leading to reputational damage or worse,” says Steve Brown, Head of Business Development at Star and a longtime compliance officer. “The fact of the matter is, private equity firms and hedge funds do this kind of disclosure now anyway. I see this as the SEC codifying what is already an industry practice in the private fund investment community. But, private investment funds are clearly now in the crosshairs of the regulator and need to take steps.”

If the SEC, then, is going to codify firm best practices, perhaps it’s time for firms to codify their best practices. In software code. Compliance software solutions allow firms to take existing policies and the manual processes needed to carry them out and translate them into automated policies and processes—readily accessible and fully configurable via applications that are easy-to-use for compliance officers and end users alike. An employee conflicts of interest monitoring system, like the STAR Platform, can cover a wide range of situations where conflicts could occur, including personal stock trading, personal cryptoasset trading, gifts and entertainment spending, outside business activity, private investments, and political contributions.  An enterprise  conflicts monitoring platform, like Star’s Compliance Control Room, automatically collects and organizes a firm’s deal-information flows into a single, centralized place so potential conflicts can be more easily spotted and dealt with.

Modern software systems like these also keep a record of compliance activities, allowing firms to easily evidence to regulators the actions they’ve taken to minimize and manage conflicts. This is especially helpful in light of another requirement laid out in the SEC’s fact sheet on its proposed private fund reform rule: The SEC is proposing to require all registered advisers to document the annual review of their compliance policies and procedures in writing.

Again, Steve Brown: “Private equity firms buy companies. Hedge funds buy securities. But both have as much need to control MNPI, supervise wall crossings, manage restricted lists, etc., as any other financial institution. Thus, a monitoring solution like Star’s Compliance Control Room is very fit for purpose in helping manage conflicts. Partnering it with an employee compliance monitoring platform, like the STAR Platform, completes a firm’s conflict mitigation capability. It’s hard to predict where the SEC’s private fund oversight effort will end up, but in my experience regulatory oversight has a tendency to increase once it’s in place, not decrease. Firms that become early adopters of compliance technology solutions tend to be in a better position to handle it all. They’re far more efficient and far less error prone.”