High interest rates, market volatility, and broader macroeconomic factors are driving asset managers to adapt their investment strategies, seek liquidity for investors, and deploy capital into attractive assets.
In illiquid private markets, adaptability has led to the growing use of general partner (GP)-led secondary transactions, particularly continuation funds. ACA, which offers scalable compliance, risk and technology solutions for financial services firms, recently delved into the regulatory considerations for continuation funds.
These GP-led secondary transactions involve a sponsor creating a new investment vehicle to acquire assets from an existing sponsor-managed fund. This allows asset managers to maintain control and management of assets that may not be ready for liquidation or are difficult to exit. Although continuation funds are not a new concept, their increasing popularity stems from ongoing challenges in capital raising and liquidity constraints, ACA explained.
Regulators, including the U.S. Securities and Exchange Commission (SEC), have taken notice of these transactions. Concerns include conflicts of interest and potential risks to investors.
In September 2023, the SEC enforced action against an adviser for breaching fiduciary duties when transferring assets between funds. The violations included failing to disclose conflicts of interest, not obtaining investor consent, and not allowing investors to liquidate their holdings in line with fund terms.
A major regulatory risk for continuation funds is one fund or adviser gaining an advantage at the expense of another. This could happen through asset transfers that disproportionately benefit one party, biased valuations, or unfair expense allocations. Many affiliated transactions fall under principal account classifications due to adviser ownership, triggering additional compliance requirements under Section 206(3) of the Advisers Act.
To mitigate regulatory risks associated with continuation funds, asset managers should consider the following:
- Reviewing fund governance documents to ensure compliance with conflict-of-interest policies and LPAC (limited partner advisory committee) engagement.
- Documenting investment decisions to demonstrate consistency with fiduciary duties and investment mandates.
- Adhering to valuation policies, including third-party assessments to determine fair asset values.
- Allocating transaction-related expenses fairly, aligning with disclosures and governance agreements.
- Seeking written LPAC or investor consent that outlines the investment rationale, benefits, and potential conflicts, even when not explicitly required by Section 206(3) of the Advisers Act.
Given the increasingly complex compliance landscape, asset managers need robust solutions to navigate regulatory challenges. ACA Signature provides tailored support, offering regulatory compliance consulting, technology-driven compliance management, and cybersecurity assessments. These scalable solutions help firms meet fiduciary duties while addressing evolving risks in the regulatory environment.
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