CREFW-Summer2015

8 / 72

CRE Finance World Summer 2015
6
R
Conrad C. Axelrod
Associate, Investment
Management Group
Schulte Roth &
Zabel LLP
Marshall S. Brozost
Partner, Real
Estate Group
Schulte Roth &
Zabel LLP
eal estate fund managers were among the myriad private
fund advisers affected by changes to the SEC’s registration
requirements under the DoddFrank Act in 20111. In the
lead-up to the DoddFrank registration deadline in March
2012, and for many months thereafter, newly-registered
fund managers faced numerous challenges when confronted
with the reality of implementing an effective compliance program.
Following the SEC’s recently announced expansion of its exam
program to focus on real estate fund managers, managers should
now prepare for those programs to be put to the test — not just on
paper but in practice.
Over the last three years, fund managers gradually adjusted to life
in the new, regulated world as they familiarized themselves with the
bulk of reporting and regulatory requirements. The volume of new
registrants and the complexity of their business models prompted
a similar engagement phase within the SEC, which responded
actively by increasing the resources and training of staff at the
Office of Compliance Inspections and Examinations (“OCIE”). As
part of this response, OCIE launched a two-year “Presence Exam
Initiative” involving focused, risk-based examinations of roughly
one-quarter of the new registrants.2 The preliminary results of
that initiative were widely publicized in the “Spreading Sunshine”
speech delivered in May 2014 by then-OCIE Director Andrew
Bowden, who reported a 50% rate of compliance violations among
private equity fund managers. 3
These findings and other recent regulatory outcomes generated
by the SEC continue to make headlines in the financial press, a
fact partially attributable to the large sums of public and private
pension funds involved. At the same time, political interest in tightened
regulation of the financial services industry has shown few signs of
abating since the financial crisis of 2008-2009. As a consequence,
transparency is one of the key themes stemming from the SEC’s
recent efforts — the underlying rationale being that even the most
sophisticated institutional investor cannot make educated decisions
or exercise contractual rights effectively with respect to matters of
which it is not adequately informed. However, some investors have
also queried the importance of the SEC’s findings and its perceived
role in protecting institutional investors in the context of freely-
negotiated management arrangements,4 and some fund managers
have expressed concerns over the preservation of legitimate
confidentiality arrangements, upon which a substantial part of
a manager’s business may be predicated.
Having identified key regulatory concerns with the private equity
model, and no doubt aware of the significant role played by real
estate in any pension fund’s asset allocation paradigm, OCIE is
now bringing its new wealth of expertise and data to bear on the
real estate sector. As OCIE turns its attention to real estate fund
managers, this article outlines some of the common compliance
concerns they may now face.
Compliance Program
In the rush of regulatory changes and last-minute amendments
to SEC rules in 2011-2012, some fund managers implemented a
“one-size-fits-all” compliance solution. Although these programs
may check the right boxes, they are not tailored to the business
of each particular firm.
From a resource standpoint, many fund managers appointed a
long-standing executive as chief compliance officer (“CCO”) and
tasked additional reporting requirements to operational staff.
However, one of the keys to an effective compliance program
(and a successful SEC examination) is an adequately-resourced
compliance staff. If the CCO wears other hats, the individual’s
operational duties should not detract from his or her compliance
role. Typical weaknesses that may demonstrate a lack of resources
include a lack of detailed documentation supporting policies,
valuation changes and expense allocations.
Although some fund managers historically have seen regulatory
compliance as an ancillary cost rather than a mission-critical
business function, the SEC’s Enforcement and National Exam
Program divisions are now coordinating efforts to identify fund
managers who lack effective compliance programs and procedures.
This initiative has already resulted in 11 enforcement proceedings
at the time of this writing. 5 Needless to say, such deficiencies
(even if not rising to the level of enforcement action) can severely
impact a firm’s investor relations, its day-to-day operations, and
ultimately its bottom line.
Annual Review
Registered investment advisers are required to conduct an annual
review of their compliance policies and procedures (Rule 206(4)-7
under the Advisers Act). In practice, this review is often broken
down into component projects that can be spread out over time
and summarized in a report at the end of the year. The steps taken
as part of the annual review should be carefully documented, and,
at a minimum should: