NAREIM Legal, Compliance & Risk meeting, key takeaways

November 8, 2024

The private fund marketing rule – and the need to disclose deal-level net returns – will continue to be a key focus for the SEC under a second Trump administration, despite the fact 100% of NAREIM members expect SEC activity to decrease in the future.

During NAREIM’s Legal, Compliance & Risk meeting, NAREIM members repeatedly heard the SEC’s rule on net return disclosures under the Marketing Rule would likely remain in force thanks to the SEC’s significant enforcement and examination divisions and that the Marketing Rule passed under the previous Trump administration.

Real estate investment managers were therefore advised this week to continue their work on deal-level net returns and substantiation of marketing materials, as well as the impact of subscription lines, in the knowledge that key components of the Marketing Rule were “here to stay”.

Key highlights from the discussion on net return calculations and practices included:

Subscription lines and the impact on returns

• The SEC is starting to increasingly “poke and prod” this issue, with the SEC starting to report deficiencies. It’s an area managers were advised to “nail down” quickly.

• A member poll revealed, half of managers (52%) are showing gross and net returns both with and without the impact of subs lines – while one in five (19%) show gross and net returns without the impact of subs line.

Deal-level net return calculations

• Half of managers (50%) are calculating gross to net discount factors on actual fund expenses compared to one quarter (27%) using a prior analogous fund and 15% using a hypothetical model portfolio.

• Challenges remain however over how to account for the J-curve – and when managers should pivot from using a hypothetical model to actual fund expenses, with some managers using a blended hypothetical model and target model to mitigate the impact of the J-curve and one open-ended fund using a since inception spread and applying it to the property-level.

• Experts noted all formulas were “imperfect”, with most vanilla vehicles using a gross to net discount factor based on spreads for the prior quarter. But, they said, there were a lot of exceptions to the vanilla.

• The key takeaway for managers was to note that SEC actions focus on whether the net is presented and disclosed in materials. “We haven’t seen actions on how the spread is calculated.”

To download the presentations and member polling from the NAREIM Legal, Compliance & Risk meeting held on Nov 7 in New York, click here.

Other key takeaways from the meeting included:

Highest fee-paying investor

While almost six in 10 managers show deal-level net returns based on the highest fee-paying investor, one-third said they didn’t – with managers largely employing a blended view instead.

Provided there are reasonable assumptions, how you calculate deal-level net returns is a difficult area for the SEC to challenge, as long as there are clear and consistent disclosures to investors within the guardrails of the Marketing Rules. 

• Key message: Be extremely clear and be extremely consistent.

Substantiate everything

One NAREIM member shared they required all materials to be substantiated – to get teams into the habit of recording data points and references. It was then down to compliance to decide what was considered “marketing”.

• Almost all members said compliance led verification efforts to ensure marketing materials and models were being substantiated properly.

• On substantiation, members heard again this was an issue “here to stay” for the SEC.

• The SEC will look hard at the use of caveats and using the investment commitment and IC memos to substantiate statements.

Ownership of risk is critical when considering developing a risk management strategy or creating a risk committee.

• One member said after identifying their core areas of risk (comprising up to 40 issues), each risk was assigned an owner who was responsible for monitoring and reporting on the risk. Another member said they assigned risk stewards, who then informally decided which risks to prioritize.

• Risk ownership needs to reside primarily with the senior leadership and board of directors – and has to be tied intimately to the business’ strategic plan.

• “Don’t do a risk assessment once and then nothing ever again. Having a regular, quarterly informal discussion on risk is better than an assessment and nothing else.”

• Use the FOREST framework to identify core risks – financial, operational, regulatory, extended enterprise (service providers), strategic and technological.

• Firms can also add in an R and an I, ie. reputational as well as investment management risk.

AI policies, compliance & oversight

• One member recommended using Colorado state’s AI legislation as the basis for developing AI policies – as the legislation, passed May 2024, was an excellent definitional tool. Click here to see the legisation.

• Some members were using AI to assist with summaries of legal communications, notices and to provide abstracts of side letters and key man provisions – manual tasks that provide high-level overviews and takeaways and save hours of work for senior team members.

To download the presentations and member polling from the NAREIM Legal, Compliance & Risk meeting held on Nov 7 in New York, click here.