The SEC is voting on a rule proposal that could overhaul an $18 trillion investment marketplace in ways that compliance experts say could have a big impact on many small to midsize RIAs.
Registered investment advisory firms that manage private funds or recommend them will be watching the Securities and Exchange Commission's
For financial advisors, though, such political debates usually take a back seat to managing the operations of their firms, which
Any small to midsize firms "would be wise to think through" an "extensive due diligence process" before launching or investing in a private fund, Gill said.
"They see the opportunities in the private funds but don't account for the compliance requirements," Gill said. "The assumption is that, as long as the fund is below a certain size, then it won't reach the radar, if you will. And that's just not a fair or wise assumption to make in the environment that we're in."
A "sizable percentage" of RIAs, especially those working with high net worth clients, currently use private funds in some capacity, according to Roberson.
"It's pretty substantial — if they're not a private fund advisor directly, they may be recommending or investing in third-party products," Roberson said. "What are the vehicles and are there any potential conflicts of interest that you haven't factored into your initial disclosures? Those things will come up, even if you happen to have a small equity position in this and this is something you haven't previously disclosed and it was part of your private fund activities."
RIAs should avoid being confused by the name of the "private fund" rules since the yearly analyses apply to all firms and may usher in "a new approach to the annual review that many small advisors aren't taking right now," Gebauer said.
"They are loath and resistant to documenting that they found something wrong. I have this conversation with advisors all the time that self-discovery of issues is what the compliance program rule is all about," Gebauer said. "There's probably a disbelief and more suspicions created by not finding and fixing problems than by issuing a report that there are no findings. It's sort of a minor part of a big rule change, but it's going to impact small advisors."
The private fund proposal carries four provisions with new requirements and two with novel prohibitions on a part of the fund industry that includes everything from hedge funds and other alternative managers to RIAs that operate their own internal or turnkey investment vehicles. According to the SEC's
- Private fund advisors must "provide investors with quarterly statements detailing information about private fund performance, fees and expenses."
- Advisors must get "an annual audit for each private fund [they manage] and cause the private fund's auditor to notify the SEC upon certain events." The auditors must be registered with the
Public Company Accounting Oversight Board , a nonprofit organization created by Congress to oversee audits of public companies and broker-dealers.
- Firms engaging in secondary advisor-led transactions that sell or exchange holdings in one of their funds for another of them must "distribute to investors a fairness opinion and a written summary of certain material business relationships between the advisor and the opinion provider."
- Private fund advisors can no longer engage in "certain activities and practices that are contrary to the public interest and the protection of investors," such as charging fees for "unperformed services (e.g., accelerated monitoring fees)" or investigations. "Prohibiting these practices would address conflicts of interest that could reasonably lead to fraud and investor harm because they incentivize an adviser to place its interests ahead of the private fund's interests," according to the SEC.
- All registered advisory firms must "document the annual review of their compliance policies and procedures in writing."
"Some of the largest private fund investors include state, municipal and private pension plans that provide retirement and other benefits to the American public," according to the fact sheet. "Based on the SEC's experience overseeing private fund advisors and the sector's impact on our financial system, our economy and American investors' savings, there is a need to enhance the regulation of private fund advisors. The proposed reforms are designed to protect private fund investors by increasing their visibility into certain practices, establishing requirements to address practices that have the potential to lead to investor harm and prohibiting advisor activity that is contrary to the public interest and the protection of investors."
For RIAs that have a private fund, the "additional back-office reporting and requirements" could mean locating a new auditor that's registered with the PCAOB alongside any lawyers used for the requisite startup filings and another third-party firm for administrative needs, Roberson said.
"If you can find a vendor that does all three, great. Otherwise you have to source all these things out," Roberson said. "If you're not knowledgeable of all the requirements going forward, then you're probably going to have to find an outsourced vendor. You want to make sure that you have a vendor or a series of vendors to cover all of the additional steps."
The fairness opinions would add to the cost of complying with the new rules, and some RIAs are wondering whether they would in turn trigger regulatory examinations, according to Gill. The quarterly and annual reports could tack on further extra expenses for RIAs, he said.
"Anytime that you're involving a third-party service provider such as an accountant, then you incur costs," Gill said. "It's the cash-strapped nature of the small-to-midsize RIA business that does have the potential to, maybe, increase fees on the client side to cover the additional compliance responsibilities."
