ADISA Video: The Latest in Everything Due Diligence
Jacob Heidkamp, FactRight’s co-president and principal, recently discussed the ins and outs of due diligence – a critical part of the investment process for broker-dealers and registered investment advisers in determining the best-of-breed products for themselves and their clients.
The video conversation, part of ADISA’s Focus on Alternatives Series, was guided by Greg Mausz, chief operating officer and senior managing director of Skyway Capital Markets.
Heidkamp of FactRight – which specializes in third-party due diligence reporting and risk management consulting for the alternative investments community – noted the regulatory evolution and innovative product development that has taken place over the last decade. He cited Next 12 Months 10-22*, more than a decade old, and recent NTM 23-08** which both delineate best practices for advisers to meet the reasonable investigation standards when conducting due diligence.
He said the other area that you have is “the evolution in the product where you have perpetual life products that are becoming much more part of the landscape, including NAV REITs, ’40 Act funds like interval funds, and tender offer funds. Those are areas where you’re having a product that’s going to have a much longer life cycle than a lot of the traditional products that were distributed in the retail channel,” said Heidkamp.
“It’s really important on those longer-term products that you’re staying up to speed on the developments that are happening … in real time,” he added, noting that their quarterly or semi-annual filing cadence with the U.S. Securities and Exchange Commission is a great resource.
The two discussed primary steps when setting up a compliance or due diligence program.
“… Put in place an investment committee process where you have a formalized review and approval process when you’re going through individual [alternatives] programs or looking at … key aspects of prior performance; the structure of the product; the markets that the sponsor is looking to invest in; liquidity provisions for shareholders; [and] really covering all the bases on the product itself, the strategy, and the personnel involved,” said Heidkamp.
Watch the full conversation above to learn more.
*With Regulatory Notice 10-22, (Obligation of Broker-Dealers to Conduct Reasonable Investigations in Regulation D Offerings), the Financial Industry Regulatory Authority reminds members of their obligations to conduct reasonable investigations of the issuers and the securities they recommend in private offerings made under Regulation D.
**With Regulatory Notice 23-08, FINRA reminds members of their obligations when selling private placements (i.e., unregistered offerings sold pursuant to the Regulation D safe harbors under Sections 3 and 4 of the Securities Act of 1933).
Video Transcript
Greg Mausz 00:09
Welcome to another edition of Focus on Alternatives, brought to you by ADISA, the Alternative and Direct Investment Securities Association. For more content like this, please visit adisa.org and check out the resource library. My name is Greg Mausz. I’m your host today joined by Jake Heidkamp. He is the co-President of FactRight. Thank you for being here.
Jacob Heidkamp 00:30
Absolutely, Greg. Always a pleasure to be at ADISA. Great educational opportunities and unparalleled networking opportunities.
Greg Mausz 00:36
So, Jake, due diligence, critical part of the investment process. It’s the first part of the investment process for broker dealers and RIAs determining, you know, what are the best of breed products for them and their clients. What’s the latest going on in the marketplace, regulatory when it comes to due diligence?
Jacob Heidkamp 00:54
I think there’s two big areas. One, there’s definitely been some regulatory evolution and there’s been some kind of innovative product development over the last decade that broker dealers and RAs really need to focus on.
First off, on the regulatory front, you have NTM 1022 from FINRA, which is over a decade old, which really provides the foundation of best practices in due diligence for reasonable investigation for a broker dealer. This was supplemented with NTM 2308 in the last year. While it does not create any new additional requirements for broker dealers, it definitely does focus on some key areas of best practice for broker dealers to meet their reasonable investigation standards when they’re conducting due diligence. Reg BI has also created some additional requirements for broker dealers to stay current on their reporting. And I think the other area that you have is you have the evolution in the product where you have perpetual life products that are becoming much more part of the landscape, including NAV REITs, 40 act funds, like interval funds, and tender offer funds. Those are areas where you’re having a product that’s going to have a much longer life cycle than a lot of the traditional products that were distributed in the retail channel that we’re going to have a life cycle of maybe three to six years. So, it’s really important on those longer-term products that you’re staying up to speed on the developments that are happening at those products in real time. And that usually includes a filing cadence of either semi-annually or quarterly with the SEC.
Greg Mausz 02:16
Okay. So that’s the first step. When they’re setting up a compliance program or due diligence program, what are some of the key steps?
Jacob Heidkamp 02:24
Yeah, I think it’s also clear from some of the SEC guidance in this space as well. What would the SEC identifies as complex and risky products that you really need to have a formalized, systematic process of going through your alternative investment due diligence. So, you need some structure to it, some homogenization how you’re approaching things and making sure that you’re covering some of the critical areas of due diligence.
Greg Mausz 02:44
So, when you say structure, can you unpack that a little bit more?
Jacob Heidkamp 02:47
Yeah, I think it’s, it’s really key that you put in place an investment committee process where you have a formalized review and approval process when you’re going through individual Alt programs or looking at a new asset manager that there’s some structure to what you’re doing, that you’re looking at, you know, key aspects of prior performance, the structure of the product, the markets that the sponsor is looking to invest in. Liquidity provisions for shareholders, really covering all the bases on the product itself, the strategy, and the personnel involved.
Greg Mausz 03:18
And so, a lot of that is definitely upfront due diligence. Digging in there and because a lot of these are longer term holds when it comes to alternatives, but let’s go deeper into the ongoing due diligence because again, longer term hold markets change. Walk us through that.
Jacob Heidkamp 03:33
Absolutely. So, I think part of this also gets into some of the product evolution in this space where we’ve seen, you know, 10, 15 years ago, a substantial amount of the products that were out there were lifecycle products where there was a capital raise, capital deployment, and then there was going to be a liquidity event at the end. What we’ve seen over the last decade is really a significant shift in some of the products to be NAV or perpetual life products, including NAV REITs, interval funds, tender offer funds, the whole 40 act structure, where you’re really looking at much more long-term hold periods and you really need to understand some of the shareholder liquidity provisions within those products because that’s going to be the exit for your investors down the road most likely.
I think another area that’s critical is if you look at some of the SEC guidance on this, that you need to make sure that with Reg BI and some of these other areas that you need to make sure that you’re staying on top of what’s going on with these programs. So, most of those publicly registered programs like the interval funds or the REITs, they’re going to have a semi-annual or a quarterly filing cadence with the SEC. And it’s really important that you’re staying on top of key developments in there, including material events, changes in personnel, distribution, sustainability analytics, capital deployment, whether or not they’re investing within the mandate that they have really to understand if there’s any style drift, really need to be sharp and stay on the ball with the ongoing reporting nets that the companies are filing.
Greg Mausz 04:53
Yeah, I really do like this latest set of products that are other more perpetual in nature. They have more liquidity. It’s great for RIAs because it allows them to manage and potentially trade out of the alternative based on their model portfolio. So, let’s talk about resource. What’s out there to equip broker dealers and RIAs to do upfront and ongoing due diligence?
Jacob Heidkamp 05:16
Yep. First, I would say a number of the asset managers in this space with these perpetual life products have really done a great job of putting together very concise reporting through the SEC and additional materials that are available for investors. Additionally, there are third party firms that can help you navigate through the space by providing updates so that you get an independent perspective on what’s transpiring at a number of these funds as well. So those resources are definitely available for broker dealers and RIAs to access as well.
Greg Mausz 05:45
And those third-party reports are such a great resource because they summarize, they dig deeper, and it allows the advisor to really keep up with the broader market and a broader array of alternatives.
Jacob Heidkamp 05:57
Yeah, absolutely. I think one of the things that you’ll see with a number of like the annual reports back in the nineties, you’re looking at 20 to 30 pages for an annual report often, and now some of these are getting over to 200 pages. So really a third-party firm can really help you distill out the key material parts of these, you know, somewhat larger filings, and it really can help you leverage your time better by entrusting some of that process to third parties as well as your own due diligence resources.
Greg Mausz 06:23
Right. Well, Jake, thank you for walking us through the latest in due diligence.
Jacob Heidkamp 06:27
I appreciate it.
Greg Mausz 06:28
And thank you for watching another episode of Focus on Alternatives. Again, for more content like this, please visit adisa.org. Thank you.
For more information about alternative investments, please visit ADISA’s resource library
For more ADISA news, please visit their directory page.
