Thursday, 25 August 2016
Last updated 14 min ago
Aug 3 2011 | 11:17am ET
By Daryoush Niknejad, Steelbridge Compliance -- The investment advisor predictions of hardship and loss since the 2010 passage of the Dodd-Frank Act have not yet come to pass. Some threatened the ejection of all outside money, or even retirement. We complained loudly as well, and understood that the accusations of inapplicability of certain regulations to private equity managers, and the belief that some measures when applied to small managers were no more than form over function. However, as advisors have begun preparing for these new regulations over the months, we have also started to hear something else, albeit quietly—and that is the upside.
In passing the Dodd-Frank Act, hedge funds, private equity funds, venture capital funds, and even some family wealth funds were swept up into the call for regulation, though many believed, reasonably, that they had little to do with the financial meltdown of 2008. The law, and the slow drip of follow-on rule-making by the Securities and Exchange Commission, limited their (and their advisors) access to capital, required many advisors to register, and many others to keep records and make detailed disclosures though not subject to registration. Still other legislation limited their ability to participate and contribute politically, suggested near responsibility for the actions of affiliates, counterparties, and even service providers, or forced restructuring of organizations to avoid or comply with such legislation. In each and every case, the legislation required at least some new expenditure.
Preparations for registration have generally meant in-depth analysis of the advisors and its funds’ businesses with a fresh set of eyes. Though advisors are looking at how their operations comply with—or even address—the myriad regulations they face, they can’t help but get a refreshed vision of the entire organization during the process. They have developed operating cultures over the years and now have the opportunity to ask why the culture developed that way and whether it still makes sense. Who has access to sensitive information? How are the portfolio managers routing trades or coming up with ideas? Why does an entity in the structure even exist?
By the time advisors start applying the regulatory regimes, they often discover that, even before Dodd-Frank, regulations applied to them that they were not even aware of, and were certainly not addressing. Some simply failed to keep certain books and records. Others went so far as openly advertising their “private” funds, having no appreciation that their funds were relying on the Reg. D registration exemption.
In addition, most advisors have been wildly structured and organized at the portfolio level in how they value assets, calculate returns and fees, analyze opportunities, and manage portfolio risk. However, they haven’t given the attention or the time to apply that same discipline to other parts of their organizations. As they work to apply the new regulations, they are finding that they have the chance (coerced though it may be) to formalize certain processes and policies. In fact, they can now pursue certain practices, like unbalanced allocation and appropriate cross trades, that they avoided for fear of increased risk and appearance of impropriety. With new procedures in place, when they rightly complain that they are doing nothing wrong and are fair to their clients to a fault, they can also now prove to regulators that that is the case.
Institutional investors need to see institutional levels of control before they will allocate resources to an advisor. Their due diligence can be akin to a mini-SEC exam in that they want to see that the advisor is organized, and has a tailored compliance manual and code of ethics addressing all applicable regulatory concerns and those of a typical institutional investor. They like to see not only that the advisor has a policy for allocations and political giving, for example, but how they apply and document the policy. They also want to know that the advisor is taking his responsibilities seriously, including allocating adequate bandwidth (whether internal or outsourced) to the task. The more transparent the response or documentation, the more likely the advisor will come away with the investment. More than one advisor has also said that, during a due diligence meeting, they are relieved to stop answering questions about why they are not registered or what exemption they are relying on, and instead quickly move on to selling the advisor and the funds.
Being a registered investment advisor also opens marketing opportunities. As discussed above, Reg. D prohibits the open solicitation of investors for private funds. Similarly, unregistered investment advisors cannot openly hold themselves out as such. However, upon the advisor registering, that latter restriction no longer applies. While it still cannot publicize its private funds, it may widely and openly advertise its services to attract investors to, for example, its particular skill with certain asset classes or strategies. This also means fewer Web site restrictions, and the ability to use marketing and public relations.
The new regulatory prohibitions now give advisors the opportunity to manage their business in the manner that is most effective and efficient. For example, many advisors’ key employees have resisted personal trading restrictions despite the advisor’s preferences, but must now contend with the specter of regular SEC scrutiny of that trading. Other advisors have felt pressure year after year to contribute to their large investors’ favorite political causes. They can now point to “Pay to Play” regulation as the reason they must now refuse. Sometimes, whether true or not, advisors simply announce, “Dodd-Frank—we can’t do that anymore”, and move on.
Daryoush Niknejad is managing director of Steelbridge Compliance. A regulatory compliance attorney who has served in-house and as outside counsel to registered investment advisors, private equity firms, and broker-dealers, he was Associate General Counsel at Highland Capital Management, L.P., a multi-billion dollar investment advisor responsible for some of the world’s largest distressed asset funds, as well as various retail and private hedge funds, CLOs, and real estate funds. While at Highland, he helped design, build-out, and test the firm’s compliance platform while also advising on derivatives trading, litigation management, and myriad strategic relationships and agreements.
Mr. Niknejad also served as Associate General Counsel at IP Navigation Group, LLC, a technology-focused family office, where he was also General Counsel to its various portfolio companies. While at IP Nav, he was the sole regulatory attorney responsible for all SEC and Blue SkyLaw compliance.
He is a graduate of UCLA and the University of Texas School of Law, and a member of Texas and California bars.