The growth of the private market has brought significantly more capital and investors to the space. And according to Amy Kadomatsu, CEO of COMPLY, this influx of funds and the increased demand for alternative vehicles has pushed regulators to act.
Within the last few months, several rules and new regulations have been adopted, including the wide-ranging Private Fund Advisers enhancements.
Upon adoption of these rules, SEC Chair Gary Gensler noted that, private funds, and those who advise and manage them, play an important role in nearly every sector of the capital markets, and that the new rules will “promote greater competition” and protect “all investors — big or small, institutional or retail, sophisticated or not.”
Alternatives Watch recently caught up with Kadomatsu to get a better understanding of the shifting dynamics within the regulatory environment and what private market providers and firms need to do now to ensure compliance with the SEC’s latest developments.
Alternatives Watch: The private market has seen a significant uptick in regulatory oversight over the past several years. What has been driving these changes? Are there different approaches that private equity firms, hedge funds and others need to consider facing these dynamics?
Kadomatsu: There has been significant growth across the private fund space over the past several years — reaching more than $21 trillion in total assets across approximately 55,000 funds, which are managed by more than 5,400 advisers. This growth is driven, in part, due to this market’s promises of diversification and increased returns, which has attracted not only worth high-net-worth investors but an untold number of pension funds, endowments and other institutional investors. As a result, the SEC has identified an increasing risk to non-high-net-worth individuals that rely on these funds and is acting in accordance, taking steps to protect this expanded investor set against fraud and unfair practices.
In addition, advisers who traditionally would not participate in the private markets have now jumped into the fray. Years of low-interest rates and yields have driven advisers and their clients to seek alternatives that deliver more investment return, and since the accredited investor thresholds are not indexed, more and more moderate-wealth individuals can now qualify to invest in private funds.
Simply put, advisers, their clients, and the larger, more significant portion of the economy represented by these funds, need more protection.
Alternatives Watch: What should compliance teams at these firms be most concerned about in the second half of 2023?
Kadomatsu: Regulatory teams across the sector must understand and plan to ensure compliance with the SEC’s enhanced regulation for Private Fund Advisers, which includes short implementation periods for certain aspects of the recently adopted rules. While many expect coming litigation, we recommend preparing now, as we don’t expect these efforts to be successful. The increased reporting requirements and the changes to auditing rules, among others, will be a heavy lift, especially for smaller players.
The SEC is laser-focused on issues surrounding custody, anti-money laundering, and know-your-customers rules. Fostering a deeper understanding of risks and exposure will be critical in the year’s second half.
Electronic communications, archiving, and marketing rules have also been predominant in the SEC’s approach in recent years. Additionally, as we get deeper into the election cycle, private funds must address political engagement issues and conflicts of interest. Finally, private funds must ensure their annual review process is well documented and well-run.
Alternatives Watch: What has been the biggest stumbling block to implementing a strategic compliance program within private market firms?
Kadomatsu: While the struggle to implement a strategic compliance program is universal, private market firms have some unique challenges. These firms tend to have smaller compliance teams and therefore often lack the time, resources, or expertise to develop a strategic, efficient, and effective compliance program.
For some firms, a deal-centric culture and the siloed nature of the deal teams may leave compliance out of the equation. Of course, these issues — namely, seeing compliance as a hindrance to growth and success — aren’t unique to private funds, but they can be amplified in the space.
The SEC has recognized that the private markets industry indirectly serves many non-high-net-worth customers through pension plans and other institutional investors that have become a significant segment of the investor base. This focus by the SEC on investor protection should push private fund leadership to prioritize their firm’s approach to compliance.
