CREFW-Summer2015

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CRE Finance World Summer 2015
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• Test the comprehensiveness of your policies and procedures,
taking into account changes in your business;
• Evaluate the effectiveness of the implementation of these policies;
• Identify compliance violations and remedial measures taken;
• Identify new compliance requirements and actual or contemplated
changes to existing policies and procedures arising from the
annual review; and
• Include a review of relevant issues by senior management.6
Annual reviews are another high-risk area that fund managers are
frequently tempted to relegate to a checklist exercise or delegate
to an external consultant, particularly if the CCO is distracted with
more pressing operational tasks. But the annual review should
be used for what it is: a serious opportunity to give your firm an
internal scorecard and, at the same time, demonstrate to the SEC
that adequate compliance resources are in place. In the modern
era of complex regulation, a simple “all clear — carry on” report is
likely to be met with some skepticism.
Personal Trading
Perhaps ironically, the conceptual gulf between liquid trading funds
(such as hedge funds) and real estate funds engenders a lack of
awareness of personal trading restrictions among real estate fund
managers, making them susceptible to violations of SEC rules.
In particular, Rule 204A-1 under the Advisers Act mandates the
establishment, maintenance and enforcement of a “code of ethics”
that prescribes certain minimum reporting requirements.
Directors, officers and partners of a fund manager, as well as
any supervised persons with access to nonpublic information or
investment recommendations (in practice this frequently means
all staff) should typically be designated as “access persons” in
this context. Designation as an access person imposes initial and
ongoing reporting obligations for brokerage accounts and other
reportable securities in which the individual has “any direct or indirect
beneficial ownership,” which includes, among others, accounts
controlled by immediate family members sharing the same household.
Personal trading violations have included situations where not all
accounts required to be reported were reported.
In addition, access persons are required to seek pre-clearance
(typically from the CCO) before participating in any private placement
or initial public offering of securities. Care should be taken to
address personal real estate holding companies in this context.
Custody Rule
Fund managers in the real estate sector frequently pursue multiple
strategies, and many successful managers operate a diverse platform
of closed-ended and open-ended funds alongside separate accounts
and deal-by-deal co-investment vehicles. Separate accounts and
co-investments continue to be a strong focus for OCIE for a variety
of reasons, but can also present a weakness under the SEC’s
“custody rule” (Rule 206(4)-2 under the Advisers Act). Registered
investment advisers are deemed to have custody of client assets
whenever they have the authority to withdraw funds from a client
account. This type of “constructive custody” should be considered
when structuring or reviewing co-investments and separate accounts.
When the custody rule does apply, client assets must be held with
a bank, broker-dealer or other “qualified custodian” (unless they
are “privately offered securities”) and there are additional notice,
account statement delivery and surprise examination requirements
(unless annual financial statement audits are prepared and timely
delivered to all investors).
In addition, real estate fund managers may inadvertently receive
physical possession of rent checks, municipal tax refunds and
dividend payments on behalf of funds that they manage (generally
due to the use of a “care of” address for special-purpose entities).
Strict compliance with Rule 206(4)-2(d)(2)(i) under the Advisers
Act requires fund managers to return such checks to the sender
within three business days of receipt — and not forward them to
the custodian bank, which may seem counterintuitive. Although the
SEC has issued limited no-action relief for certain tax refunds and
dividend payments that might otherwise be unrecoverable,7 there is
no analogous guidance for rent checks. From risk alerts to industry
conferences, the SEC has repeatedly put fund managers on notice
that the custody rule is not to be treated as a technicality, and
several enforcement proceedings have been brought in this area.8
As a result, and also as a matter of operational efficiency, many
fund managers are considering requiring their counterparties to
make all such payments by ACH or wire transfer.
Other Areas of Focus
As the SEC capitalizes on its recent exam experience with the
private equity industry, real estate fund managers should expect
scrutiny of operational areas that may appear to overlap with private
equity funds, including requirements for enhanced transparency
and reporting with respect to transaction fees, accelerated fees,
operating partners, group purchasing agreements and cybersecurity.
Critically, just because it isn’t interesting to your investors doesn’t
mean it isn’t interesting to the SEC.
Real Estate Managers Face New Wave of SEC Scrutiny