In 2012, Beverly Hills, California-based real estate investment firm Kennedy Wilson, along with hundreds of other real estate fund managers, became a registered investment adviser (RIA) with the US Securities and Exchange Commission (SEC). Most, if not all, of those firms believed that they were mandated to be registered under the Dodd-Frank Act.
As it turned out, not every firm was required to register. In fact, Kennedy Wilson terminated its registration status this past March, according to the SEC’s website. It is one of the few known cases of a real estate RIA deregistering to date.
Brynn Peltz, a partner at law firm Goodwin Procter, has noticed an uptick in interest in deregistering among her firm’s real estate clients, largely because of the difficulties those firms have faced in complying with SEC regulations. “Some of them on their own have been recognizing that’s the case,” she said. “Some had been going through inspections with the SEC and realizing that they’re not complying the way that SEC would expect them to. Even though they may have registered, they’re now reanalyzing to see if it truly is required.”
Investment managers that needed to be registered were those that invested in securities, such as debt instruments or joint ventures where a fund sponsored by the firm did not have decision rights in the partnership. However, about half of RIAs didn’t need to be registered because they either didn’t make such investments or could have restructured their investments so they would no longer have securities in their portfolios, according to Peltz.
Yet those firms still ended up registering because they typically failed to do the proper analysis and often were urged by their marketing teams to become RIAs, under the belief that SEC registration was important for fundraising.
But it can be risky to assume that real estate assets aren’t securities, because of the lack of clear SEC guidance on the issue, said Molly Diggins, general counsel at Boston-based placement firm Monument Group. Also, limited partners, in conducting due diligence on an unregulated fund manager, will inquire about the basis for a firm’s registration exemption. “A registration exemption based solely on the position that real estate assets are not ‘securities’ may cause hesitation on the part of many LPs,” she said.
The biggest concern that real estate investment managers have about deregistering, however, is how investors will perceive such a move. New York-based Almanac Realty Investors, for example, became an RIA in April 2012 and is required to be registered because it makes entity-level investments. But even if the firm did not invest in securities, it would not consider deregistering, said managing partner Matt Kaplan.
“The limited partners that we deal with would question that decision,” he said. “They have really focused in on the fact that we’re registered, that we’re in compliance.”
Many investors now have sections on SEC registration in their due diligence questionnaires, and heavily scrutinize Form ADV, which RIAs are required to file with both the SEC and state securities authorities. SEC registration “is a must if you’re dealing with large institutional investors,” said Kaplan.
“We don’t consider this an absolute mandate as of yet,” said Tony Breault, senior real estate investment officer at the Oregon State Treasury, of SEC registration. “That being said, we prefer to ensure the firms we underwrite be either registered, or if not, that they at least comply with all applicable registered investment advisor requirements. We adopt a checklist to verify compliance efforts.”
Breault added that for a manager seeking to raise funds from institutional investors, a more favorable standing with investors would outweigh the expense and potential difficulties of SEC compliance. Most investors, after all, seek managers that are registered as part of their own diligence or auditing compliance needs, he noted.
Peltz, however, argued that investors were less interested in a firm’s registration status than whether or not they acted appropriately as an adviser. “If you’re going to deregister, I think you need to look and feel like a registered adviser in connection with your fiduciary duties,” she said. “That means being upfront and transparent about fees and expenses, if you have affiliates that may present conflicts of interest. Those are things that limited partners look for in investment managers, whether they’re registered or not.”
On the flipside, it isn’t necessarily the case that a deregistered firm will have difficulty fundraising. Kennedy Wilson, for example, held a final close on its latest property fund, Kennedy Wilson Real Estate Fund V, after its deregistration. The vehicle represented the firm’s largest-ever fundraise.