In recent years, regulatory bodies like the U.S. Securities and Exchange Commission and the U.K.’s Financial Conduct Authority have been stepping up scrutiny and enforcement actions directed at private funds. For example, the SEC sharply increased enforcement actions directed at exempt reporting advisers in 2022, with at least seven of those actions directed at venture capital firms. Many of these moves relate to existing regulations, such as the Investment Advisers Act of 1940 in the U.S. or Chapter 4 of the Conduct of Business Sourcebook in the U.K.
The SEC has proposed new rules and amendments under the Investment Advisers Act of 1940 to increase the regulation of private funds. The proposed rules and amendments aim to enhance transparency for investors and would require quarterly statements detailing information about private fund performance, fees, and expenses. If enacted, the regulations could prohibit all private fund advisers from providing preferential treatment with a material adverse effect on other investors and require disclosing all other types of preferential treatment.
Any potential changes under these proposed rules will impact firm operations from front to back office. They also raise the bar for tightly managing contracts with firms’ limited partners and other investors.
To stay ahead of the curve, private equity and venture capital firms should explore ways to standardize and structure investor onboarding, fund formation, and fund obligation management. Doing so creates operational efficiency in the short term while establishing a foundation for future compliance needs. Contract lifecycle management tools can help firms achieve these benefits.
The investor document landscape
In its announcement of enforcement results for FY22, the SEC said, “unique features of private fund investment may lend themselves to certain recurring issues including undisclosed conflicts of interest, fees and expenses, valuation, custody, and controls around material nonpublic information.”
PE and VC firms should prepare to navigate increasingly robust regulations that impact investor onboarding and fund formation. Given the potential for heightened scrutiny, it is critical to embed regulatory compliance into fundraising and dealmaking workflows. Technology can streamline this process.
Firms can use technology to improve processes and manage compliance requirements for a number of documents, including:
Limited partnership agreements and subscription agreements
PE and VC firms must ensure proper drafting and execution of LPAs and subscription agreements, as any issues can result in legal and financial risks. For example, they must specify disclosures, regulatory filings, and investor reporting obligations. If any LPA provisions are not legally enforceable or violate regulatory requirements, firms are subject to legal disputes and regulatory penalties.
LPAs and subscription agreements also typically include provisions requiring investors to provide timely and accurate information and detailed reports. Using an automated and standardized tool to onboard investors can streamline the process of submitting information by walking them through it electronically.
An onboarding tool such as FundFormer by Ontra can help firms accurately collect all the necessary investor data. The solution allows firms to comply with tax, anti-money laundering, and know-your-customer requirements. It also keeps data in one place, making auditing compliance processes and responding to regulator queries more efficient.
The SEC has said it intends to take a closer look at side letters and is actively examining any preferential treatment to specific investors that could put other investors at a disadvantage. These rules would apply to all funds and are not limited to large funds or specific types of investors.
In the meantime, the SEC requires firms to comply with the terms they have negotiated in their current side letters with investors. Firms must have a robust system in place to track each of these obligations, which could include notifying investors of financial results or key person events. CLM tools help firms manage their contracts and ensure they comply with each of these contract provisions. Having a centralized, digital system to track these obligations is essential to being prepared for regulatory scrutiny.
Firms can also track and manage critical workflows by making contract data accessible and actionable.
For example, Insight by Ontra transforms documents into structured data. Working with data, firms can support and report on obligation compliance efforts by assigning and monitoring the status of tasks. Rather than depending on spreadsheets, checklists, or manual tools, firms establish repeatable processes that drive accountability and scale for meeting contract provisions and satisfying regulatory requirements. They can also generate auditable, time-based logs of events linked to each obligation for use in mock audits and examinations.
By automating these aspects of the obligation management process, firms reduce the risk of errors and save time. They can also generate reports and analytics, which help identify trends and patterns in contract management and compliance.
Firms can combine this structured data about their contracts, obligation tracking, and the ability to assign and monitor tasks to their teams in a single CLM tool to ensure they are able to meet all investor obligations and comply with the ever-changing regulatory landscape around side letters.
With the increasing complexity of regulatory requirements, firms must keep up to date with the latest regulations and ensure their documents and contracts comply. The SEC has been clear that prior contracts are unlikely to be “grandfathered in” when new rules are rolled out, resulting in the need for extensive analysis of past terms.
PE and VC firms operate in a constantly changing regulatory landscape. According to Akin Gump, “We expect the SEC’s Division of Enforcement to continue to pursue similar enforcement actions against the private fund industry in 2023.”
As a result, firms need to comply with evolving regulatory requirements, particularly those affecting investor onboarding, fund formation, and side letters. Moreover, these requirements must be managed in a comprehensive way, including the drafting, reviewing, and managing of investor documents.
By prioritizing compliance and adopting best practices, PE and VC firms can protect their reputations and avoid legal and financial risks. A proactive approach to regulatory compliance is essential. Using contract lifecycle management tools to streamline contract management can help firms better manage risks of regulatory scrutiny.