Compliance requirements for private credit funds reflect both the regulatory framework governing investment advisers and the specific considerations that arise from engaging in lending activities. Fund managers must address the standard compliance obligations applicable to registered investment advisers while also navigating lending-specific regulations that may vary by jurisdiction, borrower type, and loan structure.
Investment Adviser Compliance Framework
Private credit managers registered with the SEC as investment advisers face compliance requirements under the Investment Advisers Act of 1940. These obligations apply regardless of the specific investment strategy and form the foundation of the compliance program.
- Form ADV Filings: Maintaining accurate disclosure documents that describe the firm's business practices, fee arrangements, conflicts of interest, and disciplinary history. Private credit managers should ensure their Form ADV accurately describes lending activities and associated risks.
- Code of Ethics: Implementing policies governing personal trading, gifts and entertainment, and outside business activities. The code should address potential conflicts specific to credit investing, such as personnel having relationships with borrowers or intermediaries.
- Advertising and Marketing: Ensuring compliance with the Marketing Rule requirements for any performance presentations, testimonials, or promotional materials. Track record presentations for credit strategies require particular attention to methodology disclosure.
- Books and Records: Maintaining required records including trade documentation, investor communications, and valuation support. For private credit funds, this encompasses loan documents, amendment records, and borrower financial information.
Lending-Specific Regulatory Considerations
Private credit funds engaging in direct lending activities may encounter regulatory requirements beyond standard investment adviser obligations. The applicability of these requirements often depends on the fund's structure, the types of borrowers served, and the jurisdictions where lending occurs.
State lending license requirements represent a key consideration. While institutional lending to commercial borrowers is often exempt from state licensing requirements, some jurisdictions impose licensing obligations based on factors such as loan size, borrower type, or interest rate. Managers should evaluate licensing requirements for each state where they originate or service loans.
Consumer lending regulations, including the Truth in Lending Act (TILA) and state usury laws, generally apply only when funds lend to individuals for personal, family, or household purposes. Most private credit funds focus on commercial lending and therefore fall outside these requirements, but managers should implement controls to ensure loans are properly characterized and documented as commercial transactions.
Conflicts of Interest Management
Private credit activities can create conflicts of interest that require disclosure and management. Common conflict situations include:
- Allocation of Opportunities: When multiple funds or accounts could participate in a loan, the manager must apply allocation procedures that treat all participants fairly. Policies should address how capacity constraints, investment guidelines, and other factors inform allocation decisions.
- Principal Transactions: Transactions between funds advised by the same manager, such as loan sales or participations, require compliance with Section 206(3) of the Advisers Act and appropriate disclosure to investors.
- Co-Investment Rights: Managing co-investment opportunities fairly when demand exceeds capacity, including establishing clear criteria for allocation among eligible investors.
- Valuation Conflicts: The manager's fee income typically depends on NAV, creating inherent tension in valuation determinations. Independent valuation procedures and governance help mitigate this conflict.
Key Compliance Program Elements
- Written Policies and Procedures: Documenting compliance policies that address the specific risks of private credit investing, including loan origination procedures, borrower due diligence, and portfolio monitoring.
- Chief Compliance Officer: Designating a CCO responsible for administering the compliance program and conducting annual reviews. The CCO should have sufficient understanding of lending operations to identify compliance risks.
- Training Programs: Educating investment and operations personnel on compliance requirements relevant to their roles, including document retention, material non-public information, and conflicts procedures.
- Surveillance and Testing: Implementing periodic testing to verify adherence to policies and identify potential issues before they become significant problems.
Material Non-Public Information
Private credit managers often receive confidential information from borrowers in connection with loan underwriting, monitoring, and workout activities. While traditional insider trading concerns may be less relevant for private debt than public securities, managers should implement information barrier procedures when they also invest in public securities of borrowers or their affiliates.
Additionally, managers should establish protocols for handling material non-public information received during lending activities, including limiting distribution to personnel with a need to know and documenting the basis for any trading decisions that could be questioned.
Regulatory Examination Preparedness
SEC examinations of private credit managers typically focus on valuation practices, fee calculations, conflicts of interest, and investor disclosures. Managers should maintain organized documentation supporting valuation conclusions, including third-party appraisals, comparable transaction analysis, and model inputs. Clear records of how conflicts have been disclosed and managed help demonstrate compliance during examinations.
Questions to Ask When Building Compliance Infrastructure
- What state lending licenses, if any, are required for the fund's anticipated lending activities?
- How will allocation procedures ensure fair treatment when multiple funds could participate in a loan?
- What information barriers are needed if the manager also invests in public securities?
- How will the compliance function monitor covenant compliance and identify potential credit deterioration?
- What documentation standards will support valuation conclusions during regulatory examinations?
- How frequently should compliance conduct testing of loan origination and servicing procedures?