SEC Private Funds Rule: PEI Media Keynote Interview

Few things excite fund managers more than the idea of a crystal ball. Who wouldn’t want to know when inflation will start biting, or when gas prices will fall, or more to the point, if that investment thesis is savvy and informed, or merely wishful thinking? Who would pass up the chance to predict what a regulator may demand of their industry in the years ahead?  

Chances are, that regulator will be asking for greater transparency from the private capital industry. In the last 20 years, there aren’t too many examples of the government suggesting that the industry disclose less information about itself. In February 2022, the SEC didn’t disappoint, with new proposals that will ask for, yes, even more transparency from private fund managers.

So PEI Media sat down to discuss these proposals and what they mean for GPs looking to develop a long-term data strategy with Arthy Kumar, CFP, the director of product marketing and principal of investments and financial services at Workiva, which provides a cloud-based connected reporting and compliance platform that enables the use of connected data and automation of reporting across finance, accounting, risk, and compliance.

Q: What are the headline changes from the SEC proposals? What should private fund managers know to best prepare for when these reforms aren’t just proposals?

There are three major elements to highlight for private fund managers. First, they’ll have to prepare and distribute quarterly statements to investors within 45 days after each calendar quarter end. These statements would be required to include certain data regarding fund performance, fees, expenses, and manager compensation. The vast majority of managers already report on a quarterly basis, but those reports don’t always include every item on that list. 

Next, the SEC is proposing a mandatory, independent audit every year of the fund’s financial statements, with the results distributed to investors. Again, managers do conduct such audits, but may not do so on an annual basis. No doubt this new standard will need more time and resources. 

And finally, the SEC named a number of prohibited activities for private fund advisers, whether they’re registered or not. Most concern conflicts of interest, sales practices, and compensation schemes that the regulator finds contrary to the public good and the protection of investors. 

The big change here is that these activities were specifically prohibited, when the regulator has often focused more on a fund manager’s disclosure of things like compensation or a conflict of interest, with the idea being that so long as an investor knew about a particular arrangement, they could decide for themselves if it was acceptable. Things like excessive compensation structure tends to invite regulatory scrutiny, but this more clearly defines behavior that would never be acceptable. 

Q: These are just proposals, but some or all of these reforms will end up being adopted officially. What can GPs do now to be prepared?

So, in terms of preparation, first and foremost private fund managers need to review where their reporting process is right now. Many advisers already provide some form of periodic reporting, and all these proposed rules do is define the form and the manner of the reporting, as well as in some instances, new requirements for more detailed accounting and standardized disclosure of items that might only be reported annually. So, what they would need to do is gauge how robust their current practices are, where they need to bulk up in effort and in detail, and verify that they’re calculating metrics properly. 

Let’s take performance metrics, for example, and cross-reference those with the governing documents to make sure they’re staying true to the nature and letter of those agreements. Even after the review finds that they’re in compliance, there’s still a matter of finding the best way to manage the extra volume and rigor. And for that, I think technology can play a pivotal role in being prepared not just for the latest series of changes, but any changes that might be on the way in the next year or the next decade. 

If fund managers have to issue more robust quarterly reports and they’re not used to sharing some details more than once a year, well, now they have to ask, when do I get the data? What’s my process to aggregate it? What’s my calculation and validation and data checks? How does it eventually get reported out? And then how is it getting distributed? And a lot of those questions are addressed by tech solutions. 

Q: Let’s say that a fund manager has a pretty robust reporting platform. How should they stress test the current system to make sure it can do what they need it to do?

Let’s take a private fund manager who has a robust data system to collect all the data, and that’s great. But then the key question is how do you get that data all into a single place? Because what happens is managers are collecting structured and unstructured data that’s coming from all different sources and formats, and a lot of the time in bulk. We are well past struggling with data collection. Instead, the real challenge is validation. Data accuracy is 70 to 80 percent of the problem. How is the data aggregated and verified? 

After the stage of getting all the data into one place and reviewing it, fund managers should test how easily they can produce reports from that single source of truth, in a format that’s flexible enough to meet LP demands. We do find a lot of firms that say, “I have three different systems, and we’re ready to go.” 

But those three systems will produce multiple spreadsheets. They may have narrative text, risk language, or legal disclosures in email format or a Word doc, and then there’s the system download and perhaps other Excel files. How do I get all this together to actually create the report that needs to be produced? Take a good, hard look at just how manual that process is, because that courts error, burdens staff, and slows things down at a time when regulators are setting hard and fast deadlines for quarterly reports. 

Q: How should fund managers be thinking about staff power as it interacts with their system power during the reporting process?

At the end of the day, technology can bring everything together, but it also needs the people. What good is the technology if the people don’t know how to fully use all its advantages? But let me add this: Managers should also pay attention to how people are working right now. Where are the bottlenecks? Where is staff devoting time to inputting data manually? And those are the places where firms need to look to automating those tasks. They need to be willing to cultivate a shift in their staff’s thinking. Maybe they’re used to all those manual processes. Maybe they prefer the control they get from keeping that data in their email. And cultivating this change often means implementing new tech in phases, with sufficient training along the way. But once staff can adopt a digital mindset, they can leverage today’s systems into a powerful and efficient solution. 

Q: These SEC proposals require the input of so many disciplines, since they involve IR issues, legal counsel, staffing, and technology. How should a GP think about assembling a team to devise the best way to meet these new requirements? 

These proposals are some of the most sweeping changes we’ve seen in a while, and it’s crucial to assemble that brain trust to look at the process end-to-end. Of course, we’re going to center technology, but that’s only one piece of this. So, I think it does need that expansive evaluation from the “brain trust,” and to keep in mind that even these changes aren’t the end of the journey.  

Regulations will not suddenly vanish, and investors won’t suddenly require less transparency. Part of this process should be questions about what the future looks like, in terms of data management, reporting, and compliance. It’s not just tech. They have to look at data, at the process, and at manpower. Can the people we have do this now, and going forward? Do we need to hire outside firms? Do we need to hire implementation partners? Do we need to hire consultants? The answers may change, but the questions need to be asked over and over. That continual analysis and improvement is the only way to stay one step ahead of the future. 

Q: Large GPs may have the infrastructure to trade up to the most cutting-edge systems. How should smaller, younger firms be thinking about a reporting solution that can evolve with them?

Most firms start small, right? No matter the size, they still need to get their reporting in order to satisfy LPs and regulators. And in some ways, these smaller firms may have a greater need for an efficient data collection and reporting process because they’re operating lean and don’t have the staff for all the manual work. So we’ll start with something more basic where we then can automate the core data gathering and reporting tasks. The next phase might be looking at system integrations where the data can be centrally located and reviewed. 

Fund managers shouldn’t feel like they have to go all in and pay these exorbitant fees for some massive automation project, when the fact is, they simply want better process automation. This is a case where it’s fine to crawl, then walk, then run. When a fund manager chooses to evolve from walking to say, running, it should be based on their resources, capabilities, and the needs at the time. 

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