Optimizing Private Capital Expense Allocation for Efficiency and Compliance

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Christy: Hello, everyone, and welcome to today's webinar, "Optimizing Private Capital Expense Allocation for Efficiency and Compliance." My name is Christy DeMaio Ziegler, and I will be your moderator.

Joining us today I have the pleasure of introducing Marshall Saffer and Mitch Schulman. Marshall is the Managing Director and Head of Global Fund Sales at CSC. For the past 25 years, Marshall has provided solutions to many of the largest PE funds, hedge funds, and traditional asset managers, bringing a deep understanding of operations and strong technical background. Mitch is the founder and CEO of IntegriDATA. Prior to IntegriDATA, Mitch was Head of Operations at Citigroup Salomon Brothers Asset Management Unit. He possesses a deep understanding of operations and accounting-related processes. Mitch is proficient in his extensive experience in project and program management, technology implementation, process analysis and design, post-merger business integration, and risk management.

And with that, let's welcome Marshall and Mitch.

Marshall: Thanks, Christy.

Mitch: Thank you for the introduction.

Marshall: Thank you.

Christy: Of course.

Mitch: Pleasure to be here.

Marshall: Okay. You know what? I guess let me take it over and thank you. Let me start off by thanking everybody who's attending. We all really appreciate you taking time out from your day to kind of hear what we have to say.

We've put together the attached agenda kind of as an overview or a guide for what we'll be discussing today. Just to be clear, when we're talking about expense allocation and fund management, it really has to do with allocation of GP or any type of firm-wide expenses, down to the funds and the compliance and the workflows associated with that process. So we're going to discuss the challenges that we see. We're going to discuss how we see the current market environment, what people are currently using, how we think that we can approach the problem differently and probably more efficiently. We're going to talk about the regulatory risks and the outlooks that we see and why this problem I think is important. And then Mitch has some case studies. And then we can end with some Q&A.

I'm hoping that over the next 20 minutes, 30 minutes this will provide you with a nice overview of some concepts that we think are very pertinent for our industry and something meaningful will come out of it for you. So let me go to the next slide. Mitch is there anything you want to add, or are we good?

Mitch: No. Just a pleasure to be here. Thank you, Marshall and everyone. Looking forward to sharing some of our experiences and ideas.

Marshall: Okay So I think that the idea of about expense management and allocations, and I don't think this is a new issue, right, fees and expenses are essentially under the scrutiny and they were part of the Dodd-Frank remit, right? And the general partners are obviously obliged to disclose fees and expenses and how they're spent and the rules set and the transparency around this. And I think that with the recent fees or levies or fines that we're seeing in the industry, I think this is becoming more of an issue as people are expanding the number of funds they have. As AUM grows, as staffing constraints come into play, I think we're seeing a lot of this issue come into the forefront.

We have been talking to . . . just by way of background and how this came about is Mitch and I have known each other for a while, and we were polling our prospective client bases. And so we at CSC serve about 200 private equity and hedge fund clients, both on outsourcing services on a standalone basis and fund administration. And when we went to the clients over the past eight months, we were trying to find new services that we could bring to bear and see where the hot buttons were of what the challenges are and what type of services people might be interested in taking advantage of.

And actually this expense management and allocation problem was very high on the list with most of our current clients. And I think that the reason behind that is highlighted here a little bit in this slide, right? Mitch, do you want to talk about a little bit of what we're seeing?

Mitch: Sure. You know, I think we've been in this space for about seven years now. I think we were more or less pioneers in the space in terms of building a solution to first tackle expense allocation. It was really when the SEC began additional scrutiny on the allocation of expenses and which could be borne by the funds and which had to be borne by the management company.

We've seen over the years obviously a proliferation of additional fund vehicles, complex legal entity structures, and what we've found is that the needs and the requirements of it to perform things in a controlled manner and in an accurate manner and being compliant has kind of outstripped the demands of Excel. So we're finding more and more as folks are trying to get their arms around the process is that there's a lot of data to manage. And I think, almost in a sense, people have started to expand the definition. When we talk about expense allocation, it's sort of a misnomer in a sense because it is a conglomeration of accounts payable. It's also cost sharing. It's legal determination of whether the entity can bear a cost or not. It's intercompany accounting between the management company and all of the fund vehicles as well as portfolio companies as well as the payments to the vendors and the intercompany settlements. So it's quite a mouthful.

Marshall: You left out you vendor management, right, with contracts and everything else associated with the vendor side as well.

Mitch: That is true. That is true.

Marshall: Right?

Mitch: Yeah.

Marshall: So there's a whole lot of this. And I think what we're seeing, the reason that we've come out with this offering, this joint offering together and why we want to explore this together was it has to do with human errors associated with the problem, key man risk, operational risks, controls and procedures, and we saw a lot of our clients that just weren't doing what was required to satisfy the audit requirements and what the SEC was looking for. And there was no reason for them to dedicate the time or the personnel or buying software and staffing. We thought that this might be a good opportunity to create this new type of service that we're leveraging together. Make sense, Mitch?

Mitch: Absolutely.

Marshall: Okay. So let's talk about some of the burdens that we see. And I'm going to let you pick up here because this is your slide and you can talk about the nuances around these various components.

Mitch: Absolutely. Kind of segueing from what I just mentioned before, just in terms of the way to think of expense allocation in the broader sense, it's everything from capturing the expenses to categorizing them in terms of tagging them, what expense types, what the underlying activity was that related to the actual service or provision of product.

The actual reimbursement processing, as I mentioned before, it's typically a management company will pay the vendor and then seek reimbursement from the funds. So there's a whole reimbursement cycle and process that's independent of the actual payment of the invoice. The reporting and transparency and having an audit trail over every aspect of the process. We've seen workflows that entail not only approving for the underlying expense but also the actual fund controllers, and typically in the organizations that we serve there are multiple fund controllers, and they need to each individually review and approve of the expenses that are being allocated to their particular fund. And then there's obviously just, as I mentioned, audit trails and examination requirements that you need to have at the ready the ability to support not only, well, the underlying invoice, the service, how it was allocated and what data points were used in terms of time series data, as well as the metric. And then having a wrapper of all these internal controls and reviews to ensure that everything is accurate.

It's a process that really needs to be centralized, and that's what we're seeing more and more. I would say this is kind of an analogous to what happened in the '90s, when I was on the on the equity trade processing side and they coined the term "straight-through processing." And you're seeing a lot of what straight-through processing was to equities in the '90s, this is sort of the straight-through processing for alternative investment funds in the finance function.

Marshall: Right. Okay. So let me just jump to the next slide because I think that the solution diagram kind of highlights a lot of what you were talking about, right? It's the idea of essentially best practices of what it would be is digitizing the process, if I'm hearing you right, Mitch, right? Everything from invoice capture and audit around the invoice to dealing with the allocation component and having templating for that so the rules are followed, and then a maker and checker type concept down to the final approval and general ledger concept, right? Is that what we're talking through you think?

Mitch: Absolutely.

Marshall: Okay. Now I do have a few questions, right, because let's just talk through we've got probably a mixture of people on the phone, and I know this kind of seems simplistic. And I think when we start digging into it, it's really not. What do you see the difference happens to be between hedged and private equity processes? Do you see a distinction on the difference between those two business lines in terms of process or solutions or problems?

Mitch: Sure. I think a lot of the expense allocation methodologies, there may be some nuances that are specific to hedge versus private equity. You still have the normal metrics, things like AUM or committed capital or AUM to drive say portfolio type level metrics. And they're kind of similar in terms of hedge and PE.

But what you find in PE, when you start dealing with the holdings base or the actual investments on the PE side, typically there's complexity associated with like deal life cycles, whether a deal is pending, broken, or closed. The allocation the method and the accounting for them changes and evolves as the life cycle of a deal changes. So we may use metrics like committed capital or investment ownership in order to drive the allocations on a PE side, but then, as I said, as the life cycle of the deal changes, the accounting also evolves and there are more entries and more movements and what we call a concept of reallocation, reallocating expenses that may be held up on the management company's books until an event occurs or a life cycle change.

With respect to hedge, it's typical there's a lot of demand around holding space allocations. So holdings, it could be market value. It could be book value. It could be individual holdings, or it could be groups of holdings, like, for example, issuer or a strategy, where we need to group together the holdings, the market values of a number of securities and it could be disparate securities. A strategy could be Google and Facebook or things of that nature. So there's a lot of complexity and data complexity associated with grouping and then allocating.

Marshall: Okay.

Mitch: And then there's also the time series data. We have clients, for example, there may be a legal expenditure for a particular holding or a group of holdings and you may need to average the holdings over a period of time, over a period of three months or six months, with not only a point in time. So there's a lot of data management and processing that's required and complexity.

Marshall: Interesting. No, I mean it makes a lot of sense. Now, from a benchmarking standpoint that I think our audience might have interest, I'm seeing that it's more than one person involved in this task within a firm. I'm kind of curious, from your perspective, what do you think the before and after looks like in terms of people whose current process happens to be versus after they necessarily they might consider outsourcing or purchasing software to do this? What do you think the time savings happens to be? Do you have any idea or thoughts around that?

Mitch: Hard to quantify, but I would that the clients, there is definitely . . . Digitizing any process, you're going to see increases in efficiency no doubt. But we don't have any metrics around it. But I can tell you there's great efficiencies, especially at the C-level and controls and being able to sleep at night as well.

Marshall: Yeah. I mean, I think, from a service standpoint, right, our idea around this in terms of our coming together was to elevate it to the point where the individual managers, it becomes more of a control function than a doing function, right? It's offload all the grunt work and the menial tasks so it can become a review and an approval process for our clients, rather than actually doing the work themselves. I think that's what we're shooting for in terms of coming together for sure.

Mitch: Absolutely.

Marshall: On regulatory focus, right, I know that, Mitch, we've been focused a lot on the United States, just because we've been seeing the fines come through, right?

Mitch: Yeah.

Marshall: And that 2023, the examination priorities include calculation and allocation of fees and expenses. So we're definitely hearing more around the audit and the controls and the reviews of this, right, which is essentially driving the conversations that we're having. But I thought it is interesting also is the European Union has started to look at this as well from an AIFM standpoint, and they've put some regulation in as of May, which has to do with something similar that we've had here with the SEC on the European side. So I really think that this is a global problem as it moves forward. I don't think it's just isolated to the United States anymore. And I think the concept of putting in best practices and addressing this from a firm-wide standpoint needs to be addressed sooner rather than later if you do view growth and expansion and complexity is going to increase.

So from that, we're going to go to a case study, Mitch. Why don't you talk through because you've been very good about this, and why don't you talk about this particular case study since you put it together?

Mitch: Yeah. It's kind of a garden variety implementation and requirement that we find, where people are coming to us. They typically have a fragmented process. So it's like a lot of it tends to be emails, receiving emails, email approval, and kind of moving things along in a fairly inefficient way and fragmented way. So in the case, what we do is we typically . . . our solution will hook up to an email box. It will pull emails in. It will parse certain data and already pre-populate a form that will then go . . . it's more or less a conveyor belt, which another individual would then take that, maybe augment it with some information, and then you're already allocating it and then sending it for approval.

The whole idea is a front-to-back solution. It's eliminating that process fragmentation, where you've got vendors sending invoices in, you've got a whole nother process performing the manual allocations, and then there's another manual step of actually booking them to the general ledgers, and then another manual step of paying the vendors and another manual step, which is reimbursing the management company.

Marshall: Right.

Mitch: So what you're doing is you're . . . What we've done in this case is closed the system entirely. It's a closed system. Nothing happens offline. Everything happens within the system, and it's the workflows, it's the capture. And it's simply when data is initially captured, it's enriched and then ultimately integrated downstream to, as I said, general ledgers. It's multiple general ledgers. It's the ManCo general ledger. It's the fund GLs . . .

Marshall: Yeah.

Mitch: . . . the Genevas or what have you. And then it's also the payment processing. So this is kind of a classic case of really what our solution has done for clients.

Marshall: And I think by wrapping people around this, exceptional people that can do the work, that understand the business problem, right, it kind of solves that last mile problem to where you might buy software, you might have to staff. But with coming together with Mitch and ourselves, I think we're going to be able to provide that holistic last mile solution set that I think would be beneficial to a lot of firms out there.

But just to summarize, Mitch, this is what I heard. I heard what we're trying to do is you need to digitize, right, get this all off of paper, get this all out of PDFs, right? So you've got to digitize it. You want a template, right, the rule set. You want to assign. You want to have control over those templates. You want to come up with templates that follow the policies of your documents, right? You want to provide application control. You want to provide rule set control. You want to provide time series, right? You need to document all this. You want to make sure that the backup is there to document it. You want a whole maker and checker process for the approval is what I'm hearing.

We can define workflows that make sense for each client, right, because each client is going to have different workflows. They might have different system integration needs. They might have different processes that they need to follow that we have to adapt to. And then the idea is the periodic review of this to make sure that that everything is working the way it should and that we're following and providing the dataset and the audit trail and everything that's required to follow the SEC.

Is that correct? Is it a good summary?

Mitch: Very good summary.

Marshall: Okay. So from that, Mitch, do you have anything else that you want to add? I mean, I wanted to not take too long. I wanted this to be a meaningful discussion and not necessarily full of fluff. So I think we've provided a lot of good information. I'm hoping we did.