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  • James Lerner

Four Things I Learned About Compliance Working At A Startup Fund Manager

Being on the investment side, compliance seemed like just a ball and chain...until it came time to start a private fund of my own.

During the winter of 2015, after spending seven years in corporate advisory and venture capital, I got the opportunity to join a highly regarded team at a startup fund manager looking to raise a multibillion dollar global infrastructure fund. 

As a group of investment guys out of Australia, we set out to navigate the fund establishment and fundraising process across North America, Canada, Europe, and Australia.  For the first time in my career I had to take a deep dive into the world of financial regulatory compliance. Over the course of twelve months, numerous discussions, countless revisions to our marketing materials and investor documentation, and a lot of frustration, I learned a few things about the industry.

1. Compliance is one of the most important aspects of a financial services firm.

From the "front office" of the finance industry, it’s easy to get caught up with performance, trading strategies, portfolio companies and all the flashy and exciting aspects of the job while gaining little knowledge of, or appreciation for, what goes on in the background to make it all possible.  That was me prior to 2015.  I used to fill out my quarterly activity statements with contempt and berate the lengths we had to go to at 2 a.m. to verify a single number buried at the back of a 200 page offering document.

However, setting up a new fund manager and being exposed to international regulatory regimes, which are much more intense and onerous than Australia, gave me a completely different perspective on financial compliance.  I quickly learned that not only is it an unavoidable aspect of the financial services industry (as taxes are to earning income), it is also the foundation for the day-to-day function of a financial services business.  It sets the framework within which you market your business, document diligence on acquisition targets, keep record of meetings, backup files, submit expenses, and more.  Your compliance program essentially articulates the policies and procedures employees are to follow to ensure the business operates in compliance with all applicable legislation.

Getting this right not only sets the tone for the operational culture of your business, but ensures you have a business at all to run and are not shut down in the future for deficiencies and non-compliance down the track

2. Having a customized compliance program is imperative.

When establishing a new business in the industry, it’s tempting to take advantage of off-the-shelf products to make the development of your compliance program as quick and easy as possible – especially if you have little or no compliance experience like we did.  Or worse yet, copy and paste the compliance materials from a previous business you worked at, change out the business name and key employees, and away you go!

Every business has its own idiosyncrasies due to the products it offers, its structure, industry, or other factors. For instance, we were looking to implement a complex fee structure for investors depending on the timing and size of their investment, which would have required specific clauses in our compliance materials to stipulate how to properly keep records and report on the accuracy of the fee calculations. Using a pre-packaged template product increases the risk of your compliance program not addressing certain anomalies of your business, or having aspects that simply don’t relate to your business or that you’re unaware of and don’t adhere to.  And when your business gets audited by the relevant regulatory authorities, you’ll be more likely to be found to have deficiencies in your compliance program.  At best, this could result in a deficiency letter (in response to which you’ll need to implement appropriate corrective actions to address the deficiencies) and at worst can lead to a costly enforcement action.

This risk can be substantially mitigated upfront by taking the time to develop a customized compliance program that is tailored to your specific business.  It’s also best practice to periodically review your compliance program to ensure it’s still relevant to your business and meets current regulatory requirements.  This is especially important given the complex nature of the financial regulatory environment, which is constantly evolving to keep pace with technology and other industry changes. 

3. Not all specialists are equal and paying top dollar does not guarantee top advice.

Given we had limited experience with compliance, we relied heavily on the advice of third party specialists.  When it came to North America, we sought counsel from a top “BigLaw” firm in NYC but received ostensibly canned advice that proved to be partly erroneous.

What we were hoping would be a straightforward process turned into an expensive lesson that taught me all specialists are not created equal.  Worse, there’s currently no transparency on quality to make it easy to identify the good ones until it’s too late.  We had expected that going to a well-known firm with a strong reputation would increase the likelihood of engaging a good specialist, but even within these "top" firms the quality can vary from employee to employee.

The most time and cost-efficient approach to working through the compliance maze is to ensure you’re getting top quality, accurate advice from the outset and recognizing that paying top dollar for a reputable firm doesn’t guarantee that outcome.  Sometimes, a highly experienced individual with a wealth of knowledge in the industry can be much more valuable than a green associate at a brand name.

4. Compliance obligations come in ebbs and flows

When setting up a new business, there’s a lot of work upfront to develop and implement your compliance program. Depending on your business and particular industry, ongoing compliance requirements may ebb and flow quite considerably around reviews, filings, audits or business expansions/pivots. This makes it difficult to adequately staff your compliance team. Add to that, the unfortunate reality is compliance is often viewed as a pure cost center despite delivering pretty substantial intangible value to a firm. When we were starting out we had a limited amount of funding to get us through the fundraising process and were fully focused on cobbling together a transaction to seed the fund.

You can imagine how hard it was for our CCO to fight for budget allocation to build out a compliance team with full-time staff who may be under utilized for chunks of time. This reminded me of the cyclical nature of M&A work when I was in corporate advisory and the difficulties investment banks have getting their analyst staffing numbers right from year to year. Seeing this in multiple industries has made me a firm believer that having the flexibility to scale up and down your core team by supplementing them with external third party specialists on an as-needed basis can be hugely beneficial.

If you’ve started a financial services firm, or currently work at one, do these lessons resonate with you? Is there anything else that’s a key learning for people in the industry?