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Page Background A publication of Summer issue 2015 sponsored by

CRE Finance World Summer 2015


• 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.


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,


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.


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