CFO Forum: Confronting SEC ‘proctology’ exams

In the opening panel of the PERE CFO Forum yesterday, executives from Morgan Stanley, Paladin and Five Mile discussed such issues as coping with SEC regulation and outsourcing administrative functions.

At PERE’s CFO Forum yesterday, a panel comprising Fred Gortner of Paladin Realty Partners, Thomas Kendall of Five Mile Capital Partners and Michael Levy of Morgan Stanley Real Estate Investing discussed the top issues challenging private equity real estate firms and their senior officers today.
Of the panelists, Kendall and Levy hold both titles of chief operating officer and chief financial officer, while Gortner acts solely as chief operating officer. Kendall noted that the roles are becoming more intertwined in the industry. “We’re a financial institution, so we have a financial relationship with everything,” he said.
The panel discussed how all three firms have gone through a period of growth and evolution over the last 10 years, which has resulted in some firms outsourcing back office duties such as fund administration and accounting.
Levy noted that Morgan Stanley is in the third chapter of its growth, following a first phase of getting into the business and taking advantage of US distress and a second chapter of expanding globally and opening up the business across multiple products. The third chapter has been getting through the global financial crisis and addressing how to develop growth in a maturing industry, which included outsourcing fund servicing operations to State Street in 2011.
“You have to be very thoughtful about your organization,” said Levy. “In terms of investor reporting, compliance and marketing, can you do all of those things in-house or can other people do it better? Are you willing to give up control in exchange for efficiency in what you do?”
In contrast, Paladin’s smaller 30-person team does all of its fund administration, treasury functions, accounting and bookkeeping in-house. However, Gortner noted that Paladin evaluates this approach on a quarterly basis. “You have to step back and think about how you’re executing your business and the people who are executing it and question the current setup just because,” he commented. 
One of the biggest issues facing the industry is increased regulation from the US Securities and Exchange Commission (SEC) and the European Alternative Investment Fund Managers Directive. With rules getting stricter across the globe, Levy noted that making sure investment teams and sales professionals are compliant is a top concern. “Rules are changing, and sales people generally don’t like spending time paying attention to the rules,” he said.
Levy, who has been through a recent SEC exam with Morgan Stanley, recommended that firms evaluate the efficiency and format of their recordkeeping, as the SEC expects a quick response time. All three panelists noted that examiners often do not have experience in real estate, so firms should be ready to educate them on the minutiae of the business. “It’s no different, frankly, than the proctology exam you go through with investors and consultants as they are doing due diligence,” quipped Gortner.
At the end of the session, a poll revealed that increased regulation, the tough fundraising environment and keeping investors happy were the three biggest issues keeping audience members up at night. Gortner, however, summed up his approach to addressing such concerns: “All good things come from happy investors.”