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CRE Finance World Summer 2015

6

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Real Estate Managers Face New Wave of SEC Scrutiny

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 2011

1

. 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,

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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.

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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: