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There is no way to guarantee a successful outcome to any SEC
exam, but in light of the current regulatory and examination
patterns we have observed, real estate fund managers should
preemptively revisit the following issues:
Management fee income: Review calculation methodologies and
timing critically in order to ensure that disclosures in offering
memoranda and governing documents both match Form ADV and
align with current practice. Any deviations from the manager’s
headline fee structure (such as in connection with co-investments,
separate accounts or cornerstone investors) should be disclosed
in general terms to all investors on Form ADV.
Transaction-based and other fee income: Review all fees received
by the manager (and its staff and affiliates) for conformity with
governing documents and adequate disclosure to investors. SEC
representatives have publicly expressed an interest in this area,
highlighting the “vertically-integrated” nature of certain real estate
management models as a source of potential conflicts. Accordingly,
particular attention should be given to disclosure of real estate
operating fees, including industry-standard leasing, servicing and
property management fees. Where practical, OCIE has also strongly
supported line-item disclosure of transaction-based fees and
expenses when investors receive distributions from the disposal
of a property.
Investment-level fees and expenses: Similarly, review all fees and
expenses paid by the funds to third parties in connection with the
acquisition, holding and disposal of portfolio properties. Although
this has not historically been viewed as “best practice” within
the industry, OCIE has at times taken the position that investors
should be able to inform themselves as to the types (and potential
calculation methodologies) of typical investment-level fees and
expenses that the fund may incur by virtue of certain types of
portfolio investments.
Expense allocation and reimbursement: Ensure that expenses
charged to clients are legitimate fund expenses, within both the
terms of the governing documents of each fund (which are typically
drafted broadly) and the disclosures to investors (Form ADV
and offering memoranda). In particular, establish a written policy
prescribing the reasonable and consistent allocation of expenses
that benefit multiple clients; these vary by firm and by fund, although
some commonly shared expenses include umbrella insurance
policies, market data analyses and certain infrastructure such
as investor portals. Almost as important as the policy itself is
documentation supporting the reasonable basis of those allocations
in the context of the manager’s business. Where clients are subject
to different policies (for example, co-investment vehicles frequently
do not bear many of the typical fund operational expenses),
this should be clearly disclosed in offering memoranda and on
Form ADV.
Conclusion
Our experience of recent examinations reflects the SEC’s increased
interest in the real estate sector, and we expect this pattern to
continue for some time. As a newer group of registrants, real
estate fund managers tend to be less familiar with OCIE’s rigorous
standards and face unique challenges when confronted with their
first examination. Maintaining accurate records and documenting
steps taken in furtherance of the compliance program are vital to
this process. A thorough annual review can assist a fund manager
in identifying areas of potential weakness, but those findings must
be taken seriously. Because you will always know your own business
best, this is not a task that should be left exclusively to external
consultants. Allocating sufficient resources to the compliance
program is the key first step towards successfully implementing those
policies and procedures — in practice and not just on paper.
1 Changes to the Investment Advisers Act of 1940 (as amended, the
“Advisers Act”) contained in the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the “Dodd-Frank Act”) eliminated the widely
relied-upon “private adviser” exemption effective July 21, 2011, although
existing advisers were permitted to continue to rely on the exemption
until March 30, 2012 following an extension of the compliance date.
2 See Schulte Roth & Zabel’s Oct. 9, 2012
Client Alert
, “SEC Announces
“Presence Exams” For Newly-Registered Investment Advisers.” See also
OCIE, Letter Announcing Presence Exams (Oct. 9, 2012).
3 See Andrew Bowden, Director, OCIE, Speech at the Private Equity
International (PEI), Private Fund Compliance Forum 2014 (May 6, 2014).
4 PEI Alternative Insight, “PERE CFO and COO Compendium” (2015), LPs
on the SEC, 17-19.
5 SEC, 2015 Budget Request by Program 50. See also Julie M. Riewe,
Remarks to the IA Watch 17th Annual IA Compliance Conference.
6 SEC, Questions Advisers Should Ask While Establishing or Reviewing
Their Compliance Programs (May 2006).
7 SEC No-Action Letter, Investment Adviser Association (Sep. 20, 2007).
8 See, e.g., SEC National Exam Program Risk Alert, “Significant Deficiencies
Involving Adviser Custody and Safety of Client Assets” (March 4, 2013);
and SEC Compliance Outreach Program, National Seminar (Jan. 30,
2014), Slides.
Real Estate Managers Face New Wave of SEC Scrutiny