Regulatory Compliance for Private Fund Managers: Challenges, Changes, and Cultivating a Culture of Compliance

Regulatory Compliance
February 13, 2024

With the rise of private equity has come an intensified focus on compliance. The surge in private equity assets, growing accessibility for less sophisticated investors, increased instances of fraud, and growing complexity of securities and transactions have collectively propelled regulators to tighten their oversight over the industry.

New regulations will present new challenges for private equity firms. So, what can firms do to stay one step ahead of the evolving regulatory landscape?

It starts with instilling a culture of compliance.

In this article, we discuss the reasons behind the rise in global regulation for the private funds industry, the challenges it poses for General Partners (GPs), and why instilling a culture of compliance is essential for firms to thrive in this increased regulatory environment.

The Gradual Shift Toward Increased Regulation

The growth of the private equity industry in recent years has been exponential. According to PWC, assets under management in private capital reached $12 trillion at the end of 2023. The combination of this growth, heightened complexity, and increased accessibility for less sophisticated investors has put the industry under the regulatory spotlight. Regulators are keen on ensuring stability in global markets and protecting investors as they navigate the evolving landscape.

Regulation creates new challenges for private equity GPs. Regulation and compliance are not new for GPs, but navigating and meeting frequently changing global regulatory requirements will continue to pose challenges for private equity firms.

On August 23, 2023, the U.S. Securities and Exchange Commission (the “SEC”) announced the implementation of the Private Funds rule. The new rules will significantly impact both Registered Investment Advisers and Exempt Reporting Advisers, underscoring the importance of establishing a strong compliance culture from the start. Later, on October 16, 2023, the SEC’s Division of Examinations announced its 2024 examination priorities. Notably, there will be an increased focus on Registered Investment Advisers of private funds pertaining to the oversight and approval procedures concerning fees and expenses, including fee calculations, as well as performance metrics. Adapting to these regulatory requirements and remaining proactive is essential in a dynamic landscape.

New Challenges for Management Companies

The enhanced focus on expense management underscores the pivotal role played by GPs through their management company vehicle in being the keepers of accurate books and records that are compliant with applicable regulations. Heightened scrutiny over accurate allocations, record keeping, and associated disclosures increases the need for focused and experienced teams to oversee the accounting and other related functions at the management company. Insufficient oversight introduces risks that can lead to inaccuracies at the management company and fund levels, potentially resulting in SEC enforcement action.

The SEC Private Funds Rule now mandates private fund managers to provide investors with quarterly statements detailing fund performance, investment costs, fees, expenses, and certain adviser compensation. In addition, private fund advisers may not engage in certain activities that would cause potential harm to investors, including charging fees or expenses related to an adviser investigation, without disclosure and consent from fund investors. The rules also prohibit charging regulatory, examination, or compliance fees without proper disclosure, reducing adviser clawbacks by certain taxes without disclosure, or charging fees related to a portfolio investment on a non-pro rata basis without fair and equitable allocation and advance written notice to LPs.

Failing to adapt to these regulatory shifts, whether due to insufficient staff or outdated policies, could force firms into a last-minute scramble to meet deadlines. Simply being aware of impending changes isn't enough; understanding their implications and adapting proactively are absolute necessities in this dynamic regulatory environment.

Setting the Tone for a Culture of Compliance

It is essential to embed compliance into the culture of the GP, including appointing a person or team to oversee this dynamic area. Beyond that person or team, though, the entire firm should be trained and sensitized to the regulations and made to understand that compliance is a goal of the firm. The “tone at the top” is critical here – i.e., all GP employees must perceive buy-in to regulatory compliance efforts from the GP’s most senior management.  

Engaging the help of an experienced service provider offers GPs the support they need to stay on top of regulatory compliance and management company reporting requirements. As the complexity of running a private equity firm intensifies, the appeal of aligning oneself with a single-source provider increases. GPs can leverage the expertise of a service provider to highlight what needs to be done and how to do it, but ultimately, the GP is responsible for compliance.

How Petra Can Help

Petra Funds Group’s Regulatory Compliance and Management Company Accounting teams have decades of experience managing the growing complexities of SEC reporting and accounting for private investment firms and their management companies. This expertise enables them to provide practical insight and guidance on establishing best practices to stay ahead of regulatory demands. Learn more about Petra’s fund administration solutions here.

Reach out to Sean Menon or Jesse Brown with any questions you have about this topic.

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