COVID-19: Practice Note: Compliance Checklist For Private Fund Managers During A Pandemic

The global COVID-19 pandemic has affected virtually all businesses. Some have scaled back operations or close completely, while others have enacted business continuity plans (BCPs) and have ordered employees to work from home. Private fund managers have faced many of the same operational challenges, in addition to having to contend with horrific market conditions marked by a lack of liquidity, extreme volatility, and a bear market in almost every asset class.

Amid such challenges, compliance and risk departments and senior managers at private funds are also under enormous stress to perform for their investors. The slightest misstep can have wide-ranging and negative implications, potentially risking the demise of a firm.

Below, we provide a checklist of reminders and suggestions for private fund managers working to get through the pandemic. The list addresses regulatory, continuity, economic and market-related risks.

Business continuity and technology challenges and tasks

— The first step in enacting an established business continuity plan (BCP) is to review the document and asses any vulnerabilities it might not address. The current pandemic may have similarities to a natural disaster such as a hurricane, but different challenges are sure to arise.

— The BCP should detail work-from-home arrangements, the expected duration, and which employees will perform which functions. Key personnel, backups, and their contact information must be identified and verified.

— Technology solutions for remote working are essential for portfolio management operations, accounting, and compliance functions. The speed and stability of internet connections and the capacity of VPN connections must be tested and verified. Security and cybersecurity reminders and safeguards are critical.

— Licenses of software and services should be reviewed to ensure they permit possible sharing and remote access.

— Employees should be reminded of the heightened cybersecurity risks of working remotely, specifically phishing and ransomware attacks. Remote workers must also be reminded of the necessity to safeguard customer records and privacy information. Consider prohibiting the printing of any business documents at home.

— Protecting data at all costs is essential. Keep the workforce informed on cybersecurity solutions for computers and networks. Enforce policies regarding personal computers and phones and what data can be accessed by whom.

Market, portfolio and vendor risks

— Consider and review market prices and valuations policies and procedures, mainly related to illiquid or hard-to-value securities. In cases where securities are illiquid, or valuation is in doubt, consider the pros and cons of “side-pocket" provisions, which segregate liquid from illiquid assets, in fund documents.

— Portfolios should be stress-tested, perhaps more frequently than under normal conditions. Volatility, liquidity, leverage and multiple risk measures should be considered.

— Consider whether and how vendors can fulfill their obligations. Speak with counsel about how contract terms can be altered, and emergency provisions triggered. Force majeure or unforeseeable-circumstances clauses are not as straightforward as one might think, and there can be a high hurdle to meeting unique terms.

— Private funds that trade cleared and uncleared derivatives should review contracts and asses the risk of counterparties, the ability of futures commission merchants (FCMs) to settle contracts, and the risk of unintentional events that could trigger defaults or terminations.

— Managers should monitor margin requirements by FCMs, custodians, and prime brokers. During times of increased volatility, clearinghouses and FCMs may change requirements unexpectedly. Therefore, caution and flexibility are essential.

— Legal departments should ensure that International Swaps and Derivatives Association (ISDA) master agreements and other essential financial arrangements such as credit facilities cannot be terminated as a result of the pandemic.

— Essential service providers and their BCPs must be able to ensure that their services will be uninterrupted. They include executing brokers, banks, custodians, FCMs, prime brokers, accountants, administrators, tax accountants, lawyers, and auditors.

Business, customer and client risks

— Review "key person" provisions for if a portfolio manager were to become ill. Is there a backup plan of coverage that is in accordance with the management and partnership agreements?

— A uniform or scripted message to investors and the public must be created and approved. Only authorized people or a point person should speak with customers or the public and media about the confidential activities of the fund such as exposures, changes in strategy, and performance.

— Video conferencing with customers should replace in-person meetings to provide updates and ease concerns by investors that systems are operational and functioning smoothly.

— Customer concentration risk should be evaluated. If a large or disproportionate percentage of a client base is affiliated or related, such as through fund of funds, or family offices, managers should be aware that the risk of loss of a customer can become contagious.

— Managers should review management agreements and the specifics surrounding "high water marks" or "clawback" provisions. Many firms operate with thin management fees and rely heavily on performance fees for compensation, particularly key personnel such as portfolio managers. The disappearance of performance fees could lead to operational losses for management firms.

— Review appropriate fund documents and consider whether subscriptions and redemptions should temporarily be suspended, or "gated" due to volatility and valuation risks.

— Prepare for customer redemptions as investors experience and manage their own liquidity and risk problems. Forecasting of redemptions is necessary for liquidity and risk calculations.

— Consider the availability and pros and cons of payment-in-kind (PIK) distribution provisions as well as side-letter or side-pocket provisions.

Compliance and regulatory suggestions

— Independent directors should be kept informed throughout the process of enacting a BCP, and their availability for emergency meetings or calls should be verified.

— Archiving communications between staff and clients is a common work-from-home pitfalls. Reminding and training remote workers of this essential task, along with other safeguard measures, is vital.

— Firms should try to avoid taking up the Securities and Exchange Commission on its recent offer for regulatory relief to delay filings and delivery obligations for an additional 45 days where the original due date falls between March 13 and prior to April 30; may be seen as a red flag. Routine filing obligations such as Form ADV, Form PF, and position or holdings reports such as 13D and 13F reports should not be interrupted or delayed if possible despite the offer of an extension.

— Compliance departments should review policies and procedures and be certain that despite and altered work environment, employees can perform all necessary functions in a manner compliant with written policies.

— Compliance and IT departments should review of all IT infrastructure and remind employees that despite changes to work environments such as working remotely, supervision and enforcement of policies will continue.

— Compliance should confirm that all employees retain access to all necessary tools such as restricted lists, policies and procedures, pre-clearance requests, and open communication channels to all necessary individuals such as compliance, legal, risk, and senior managers.

— Firms must ensure that investors receive required information such as audited financial statements, monthly or quarterly account or capital statements, and other required disclosures such as privacy policies, and regulatory filings such as Form ADV.

NOTE: Please visit the Thomson Reuters COVID-19 resource center for additional resources. For a regularly updated list of U.S. regulations related to the COVID-19/novel coronavirus update, please click on this link to the Skopos Labs Coronavirus Policy Tracker>

Written by:

Thomson Reuters Regulatory Intelligence and Compliance Learning

Thomson Reuters Regulatory Intelligence and Compliance Learning on:

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