Mastering Compliance: Navigating Regulatory Risks in Continuation Funds
In today’s financial landscape, high interest rates and market volatility are prompting asset managers to reassess their investment strategies. The need for liquidity and the pursuit of attractive assets have led to a notable increase in the use of GP-led secondary transactions, particularly continuation funds.
Understanding GP-Led Secondary Transactions
General partner (GP)-led secondary transactions represent a strategic response to challenges in private markets. These transactions typically involve a sponsor establishing a new investment vehicle to acquire assets from an existing fund managed by another sponsor. This structure allows asset managers to retain control over assets that may not be ready for liquidation or are difficult to exit.
Why Continuation Funds Are Gaining Popularity
Though the concept of continuation funds is not new, their appeal has surged due to:
- Ongoing challenges in capital raising
- Liquidity constraints affecting asset managers
- The need to manage assets effectively without requiring immediate liquidation
As the U.S. Securities and Exchange Commission (SEC) closely monitors these transactions, concerns about potential conflicts of interest and investor risks have emerged.
Regulatory Risks and Compliance Considerations
The SEC has recently intensified its focus on compliance, as demonstrated by a September 2023 enforcement action against an adviser for fiduciary duty violations. The infractions included:
- Failure to disclose conflicts of interest
- Not obtaining necessary investor consent
- Preventing investors from liquidating their holdings as per fund terms
These actions highlight a significant regulatory risk: one fund or adviser could gain an unfair advantage at the expense of another through improper asset transfers, biased valuations, or unfair expense allocations. Such transactions often fall under principal account classifications due to adviser ownership, triggering compliance obligations under Section 206(3) of the Advisers Act.
Best Practices for Asset Managers
To mitigate regulatory risks associated with continuation funds, asset managers should implement the following strategies:
- Review fund governance documents for compliance with conflict-of-interest policies and ensure effective LPAC (limited partner advisory committee) engagement.
- Document investment decisions to showcase adherence to fiduciary duties and investment mandates.
- Follow rigorous valuation policies, including utilizing third-party assessments to ascertain fair asset values.
- Allocate transaction-related expenses equitably, in accordance with disclosures and governance agreements.
- Obtain written consent from LPAC or investors, detailing the investment rationale, benefits, and potential conflicts, even when not explicitly required.
The Role of Technology in Compliance Management
As the regulatory landscape becomes increasingly complex, asset managers require robust solutions to navigate these challenges. ACA Signature offers tailored support, which includes:
- Regulatory compliance consulting
- Technology-driven compliance management
- Cybersecurity assessments
These scalable solutions are designed to help firms fulfill their fiduciary duties while addressing the evolving risks present in the regulatory environment.
For more information, read the full story on ACA’s insights into continuation funds and compliance strategies.
