Over a year ago, OCIE released the Risk Alert, “The Most Frequent Advertising Rule Compliance Issues Identified in OCIE Examinations of Investment Advisers.” While the alert highlighted several areas where performance advertising is involved, our recent CSS/Ascendant conference panelists in a session entitled “Best Practices for SEC and GIPS Performance in the Private Fund Space” noted that it is clear that hypothetical and back-tested returns continue to be a huge risk area. If it’s hypothetical, firms simply cannot be clear enough in their disclosures. Given that it’s hypothetical, it fundamentally didn’t happen, so there has to be a lot of disclosure about how it was created.
Robert Conca, Partner at Jacko Law Group mentioned that early on in the regulation of private funds and registrations, it became apparent that the rules don’t really apply like they do to other registrants. That thinking has certainly changed, and private funds are placing more importance on ensuring they’re buttoned up from a regulatory perspective. Additionally, clients are starting to ask more about GIPS compliance from private funds.
Appropriately representing returns to qualified investors stands as a major issue for Managing Partner Sidney Hardee of Hardee Brothers. His goal is to make sure the investors understand the full scope of the funds, which include the strategies, expenses, and returns. Additionally, he’s a strong proponent for having the Chief Compliance Officer, Chief Risk Officer, and Chief Investment Officer viewed as equal partners. Ensuring they all have an equal voice is important to make sure everyone is heard, and buys in to the final product.
Arin Stancil, Managing Director of Guardian Performance Solutions LLC noted that when typically thinking about private funds, GIPS compliance doesn’t always come to mind. As the GIPS standards are presently written, the applicability just simply isn’t there. For example, GIPS focuses on composites, which don’t jibe with the concept of selling private investments. The proposed “GIPS 2020” revised standards are an attempt to make GIPS more applicable to private funds. This improvement may lead to more private funds seeking compliance with the GIPS standards.
Other issues linger. Fees and expenses disclosures, for example, remain problematic. Disclosures around these should be much more thorough than was typically seen just a few years ago. These disclosures are expected by the examiners regardless of a firm’s size or investment philosophy. Be sure that multiple people read the disclosures to ensure everyone is on the same page, including the firm’s accounting/finance person/department. The worst thing an adviser can do is nothing, especially when an issue is identified. Firms have to demonstrate they care. It’s better to try and fail than to do nothing at all.
The regulatory focus on private fund issues will only continue. Rules and regulations apply. Continue to preach tone at the top, continue to fight for sufficient resources, continue to emphasize compliance as a strategic business partner. Firms must be able to demonstrate a strong culture of compliance, that policy and control breaches are not tolerated, that the firm is proactive in seeking to identify risks, and that supervisors are effective role models within the organization.
Post written by Dan Haynes