Regulatory Compliance Concerns for Private Fund Managers

Year in Review

The year 2022 was a busy time for private fund regulations in the U.S. The Securities and Exchange Commission (“SEC”) released various risk alerts, issued significant enforcement actions, and proposed regulations for additional transparency from private fund managers.  

SEC Exam Findings and Risk Alerts. The SEC announced that it filed 760 enforcement actions in 2022, which is an increase of 9% from the previous year,^[1] and issued various risk alerts which identified common deficiencies for investment advisers.

New Regulations. The updated advertising and marketing rules went into effect in November and require investment advisers to adhere to higher standards when communicating testimonials, endorsements, third-party ratings, and hypothetical performance in advertisements. 

Proposed Regulations. The SEC drafted various proposed updates to the existing regulations in 2022.  Notable are the expectations identified in the proposals for the Private Fund Advisers Rule, Cybersecurity Risk Management Rule and the recently proposed Outsourcing Rule that, if adopted as proposed, would require registered investment advisers to meet specific requirements when outsourcing certain activities. You can watch this on-demand recording on the impact of the 2022 private fund regulations on chief financial officers (CFOs), chief compliance officers (CCOs), and chief technology officers (CTOs).

What to Expect in 2023

Continued Enforcement and Personal Accountability. If the SEC’s trend continues, private fund managers can expect more general sweep examinations, stricter enforcement, and increased fines for identified efficiencies.  The SEC highlighted its focus on individual accountability, indicating that more than two-thirds of the stand-alone enforcement actions in 2022 included an individual defendant.  

Advertising and Marketing Standards. The new rules replace guidelines that private fund managers have relied upon in the past and use principles-based prohibitions which will continue to be interpreted over time. Private fund managers will continue to rethink how they present performance, so marketing and compliance teams should expect to collaborate even more as they update and develop pitch decks, performance tables and other communications.

Expanded Role of Compliance. If the proposed regulations are finalized, compliance will require a collaborative approach from CFOs, CCOs, and CTOs to provide the expected level of transparency into the firm’s activities.

Required Oversight. If the proposed rules to address outsourcing by investment advisers are finalized, private fund managers will be responsible for identifying service providers that perform a “covered function” and then assessing the risks and monitoring the vendor’s performance.  However, vendor risk management is not new and, even in the absence of this rule, private fund managers will still be responsible for outsourced activities.

Demand on Data. Private fund managers that have a defined data-management framework in place to accurately calculate performance information and cross-reference governing documents will find it easier to comply with the proposed quarterly investor reporting requirements.  

Higher Expectations for Cybersecurity Risk Management and Reporting.  Recent enforcement actions indicate that the SEC will be heavily focused on the firm’s ability to safeguard data and seeking personal accountability from management.  Further, if the cybersecurity rules are finalized as proposed, fund managers will need to implement well defined procedures to accurately report cyber incidents within 48 hours.

Innovative Compliance Technology. Many of the proposed rules were met with criticism from smaller private fund managers that are unable to hire costly compliance personnel to support the requirements. Regulatory technology (“RegTech”) vendors are defining solutions to stay abreast of the regulatory requirements, manage the interdependencies of data for reporting and automate compliance tasks.  

[1] https://www.sec.gov/news/press-release/2022-206