AIQ Fall 2018

Q U A R T E R LY

ALTERNATIVE INVESTMENTS QUARTERLY

FALL 2018 VOLUME 12 ISSUE 3

A CLOSER LOOK AT INFLATION,

and What it Means for Investors I Opportunity Zones Program: Qualified Funds and Related Tax Incentive I SEC Proposes “Regulation Best Interest” Rule Package I Solving Your Talent Management Problem I ADISA News

Q U A R T E R LY

FALL 2018 VOLUME 12 ISSUE 3

1 — President’s Letter

ALTERNATIVE INVESTMENTS QUARTERLY

2018 and Beyond...

ADISA EDITORIAL BOARD

2 — Executive Director’s Letter

Chair I Brandon Raatikka I FactRight, LLC Peter Magnuson I Securities America

You’re at the ADISA Event

Because…?

CONTACT INFORMATION

4 — A Closer Look at Inflation and

ADISA I 10401 N Meridian St., Suite 202 I Indianapolis, IN 46290 Direct: 317.663.4180 I Toll Free: 866.353.8422

What it Means for Investors

Fax: 317.815.0871 I E-mail: adisa@adisa.org John Harrison I Executive Director I 317.663.4172

10 — Opportunity Zones Program:

Tanisha Bibbs I Director of Event Planning I 317.663.4174

Qualified Funds and Related

Jennifer Fitzgerald I Director of Marketing I 317.663.4175

Tax Incentives

Tony Grego I Associate Executive Director I 317.663.4173 Erin Balcerzak I Member Services Coordinator I 317.663.4183 Design I DesignMark I Susie Cooper

18 — SEC Proposes “Regulation

Best Interest” Rule Package

adisa.org Copyright © 2018

By ADISA (Alternative & Direct Investment Securities Association), formerly REISA, formerly the Tenant-In-Common Association.

All rights reserved. Readers may copy sections of this publication for personal use. However, it is a violation of U.S. copyright laws to

20 — Solving Your Talent

Management Problem and

Increasing Your Business

by 40%

copy substantial portions of the publication for any reason without permission. The Copyright Act of 1976 provides for damages for illegal copying. If you wish to copy and distribute sections of this publication, contact Jennifer Fitzgerald at jfitzgerald@adisa.org.

26 — ADISA News & Events

President’s Letter

2018 and Beyond…

By Keith Lampi, President of Inland Private Capital Corporation (IPCC), 2018 ADISA President

As autumn officially sets in, the clichés of fall once again apply in 2018; the leaves are changing colors, football season is underway, the kids are back to school… and ADISA is prepping for its Annual Conference & Trade Show which will take place at the ARIA Resort & Casino in Las Vegas: Tracking with recent years’ past, attendance this year should hit another record level, with more than 1,000 industry professionals who span the gamut of membership categories. While this data point highlights the growing success of the association, it also signals an energy and desire of our membership base to engage in discussion, debate the important issues, and become proficient in new areas, which encapsulates ADISA’s core value proposition: Networking—Advocacy—Education.

The alternative investments industry has undergone a robust expansion over the past several years, largely driven by investor demand seeking direct access to product strategies that enhance portfolio diversification and investment performance. Mainstay product types—REITs, BDCs, interval funds, energy funds and securitized 1031s remain a staple in the conference program. In addition, tremendous growth has occurred throughout new product categories such as private equity, numerous strategy-specific real estate private placements, and qualified opportunity zones (QOZ’s), a recent offshoot of tax reform legislation. Clearly, this expansive suite of product alternatives, both new and established, provides our membership plenty to sort through, which will continue to drive diligence conversations and legislative and regulatory considerations across the spectrum for years to come.

Now is an exciting time for our industry, and while ADISA is known for putting on an excellent networking event where a myriad of topics are tackled throughout formal presentations, panel discussions, and hallway conversations, our events only scratch the surface of ADISA aspires to accomplish. ADISA’s broader mission is predicated on its ability to shape our evolving industry’s path forward into the future. This can only be accomplished through continued membership involvement. Our committee structure allows members to engage at all levels with the common goal of driving progress for the long-term betterment of a thriving industry that acts in the best interests of investors. I encourage each of you to get involved.

Thank you for your continued support, and I am looking forward to seeing you in Vegas next month!

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Executive Director’s Letter

You’re at the ADISA Event Because…?

By John Harrison, Executive Director, ADISA

First, let’s get one underlying factor out of the way: we are technically here on the “public dole.” But that’s OK because in this case it actually makes sense, and everyone who is a member of an association benefits.

That’s right, in not charging income taxes to trade associations (and, of course, charities too), the U.S. taxpayer grants that trade associations are performing a public service to directly help society run more smoothly. So that’s our charge from God and Country; now how exactly do we enact that in our events. Let me list the Top Ten ways:

10.

Venues—carefully researched hotel and city

5. Professionalism on stage—only about a fourth of

venues give easy access, attractive city backdrop and

the sponsors and suppliers in attendance become

convenient meeting footprints.

involved in speaking in the program. It’s not a program

9. Staff—top notch ADISA staff and personnel (Tony,

where folks pay to give their shtick or pitch; only

Tanisha, Jennifer, Erin, Kim, Jill, Julie, Dave, college

pertinent topics which pass the review committee are

student volunteers, and yours truly) go the extra mile to

allowed on stage.

elevate the event.

4.

8. New

entrants—ADISA events are the place to

in attendance complimentarily has had to qualify

explore new people and investment products in

with credentials and job category to attend; and we

our space.

provide honest stats--no need to fluff up the customer

7. Great value—our pricing is developed by a board committee of the “member-customers,” and as a notfor-profit we are here first to provide value and secondly to cover the cost of production; independent auditors

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Quality of attendees—each Associate member

numbers here!

3. Important

updates—the latest regulatory affairs

and overall industry-shaping trends are explored and explained.

review our financials annually.

2.

6.

Fair policies—our event-related policies work to

presentation formats to the business conversations in

keep a balanced program: the conference sessions

the hall to the after-hours camaraderie, ADISA events

are technical and educational, and the commercialism

buzz with excitement.

is limited to the exhibit; policies on appearance limits,

1. Everybody’s here—this is the annual check-in point

presentation review, and committee oversight give a

for everyone who’s anyone in the retail alternative

fair take on the industry.

investment space. That’s why you’re here!

FALL 2018

Electric atmosphere—from the mix of new

1. Everybody’s here—this is the annual check-in point for everyone who’s anyone in the retail alternative investment space.

That’s why you’re here!

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A Closer Look at Inflation and What it Means for Investors

By RESOURCE

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FALL 2018

Resource is an asset management company that specializes in real estate and credit investments. The company’s investments emphasize consistent value and long-term returns with an income orientation. Resource is a wholly-owned subsidiary of C-III Capital Partners LLC, a leading real estate and credit investment management and commercial property services company.

When discussing the economy, inflation is a pain point that should always be part of the conversation. Consumers tend to hate it and the Federal Reserve usually fears it. But in order to gauge it, there are a few key metrics to consider.

Gauging the inflation gauges The price index for Personal Consumption Expenditure (PCE) is based on surveys of what businesses are selling. The Consumer Price Index, or CPI, is based on surveys of what households are actually buying. This difference highlights two key points: their weight and scope effects.

When it comes to weight differences, PCE is a broader measure that covers movements in economic activity. Overall, it is not as sensitive to certain sectors like housing. The issue here is that sectors like housing may preview economywide inflationary environments. For example, roughly 33 percent of CPI is weighted to housing, while the weight of shelter is just 16.4 percent in PCE.1 Scope differences are an even more important factor. Consider healthcare as an example. Typically medical care is not paid out-of-pocket by consumers.

Instead, it is partially paid by employers to cover insurance premiums or partially covered by the government through Medicare and Medicaid. However, they have different market dynamics than the services directly available to consumers, such

The price index for Personal Consumption Expenditure (PCE) is based on surveys of what businesses are selling. The Consumer Price Index, or CPI, is based on surveys of what households are actually buying.

This difference highlights two key points: their weight and scope effects.

as what is sold through the healthcare exchange at healthcare.gov. Additionally, Medicare and Medicaid are not market based. Those costs are adjusted by the government, and therefore, using them as a measure of economic activity can mute the overall view of the market. Scope differences like these can account for the systematic divergence between PCE and CPI.

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Considering this, is PCE accurately reflecting today’s inflationary environment? It has definite flaws that make it more conservative in the pick-up of inflation and deflation. For example, CPI picked up the extreme deflationary environment postRecession, when PCE did not. CPI is also showing a pronounced rise in inflation since 2017 compared to PCE. This may be something to keep a closer eye on in 2018 and 2019.

Looking at other underlying data Besides PCE and CPI, there are numerous other data points that can help forecast inflation. One such example is the New York Fed’s Underlying Inflation Gauge, which includes the value of financial assets, and therefore captures a more robust picture of the economy. Recently the metric registered an 11-year high of 3.3 percent. This data point may suggest that both inflation and interest rate hikes are about to accelerate.

The price index for Personal Consumption Expenditure (PCE) is based on surveys of what businesses are selling. The Consumer Price Index, or CPI, is based on surveys of what households are actually buying. This difference highlights two key points: their weight and scope effects.

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Chart 1

Measuring Inflation: CPI vs. PCE

Bloomberg. U.S. Personal Consumption Expenditure Core Price Index YoY SA Index and U.S. CPI Urban Consumers YoY NSA. 6/29/07–6/30/18.

Chart 2

New York Fed’s Underlying Inflation Gauge

Federal Reserve Bank of New York. Underlying Inflation Gauge. 6/1/02–6/1/18.

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You can also examine wage growth as an indicator. Wage pressure can lead to broad-based price pressure, which can lead to broad-based inflation. Typically, labor is the largest input into the production of goods. And, at this stage of the economic cycle, as the labor market tightens, wages tend to rise, as employers are looking at a smaller pool of workers to meet their growth needs, resulting in higher price and wage inflation.

Chart 3

Rising Wages in Private Sector

Bureau of Labor Statistics. Wages and salaries in private industry, 12-month change, NSA. 6/06-6/18.

What does inflation mean for investors?

No matter what metric you examine, it is clear that inflation is trending higher, and it may be time to help your clients rethink their investment decisions.

Earlier this year, CPI exceed expectations with a 0.5 percent increase, and as a result, markets reacted sharply.2 Equity investors panicked, fearing higher inflation and a more aggressive pace of Federal Reserve rate hikes. This left many reassessing the value of their equities and corporate bonds.

It is important to understand that investors have the ability to hedge against inflation with alternative allocations. Investments in real estate have historically served as a hedge against inflation.3 Unlike equities and bonds, real estate has the potential to capture income from properties as prices rise. Floating-rate corporate credit also has the potential to protect against inflation. These floating-rate coupons react inversely to traditional fixed coupons as rates rise, and pay a variable interest rate that rises as rates do, generating higher potential income for portfolios.

At the end of the day, while inflation and rising interest rates may cause concerns, it is important to remember that you have options to help your clients in this environment.

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At the end of the day, while inflation and rising interest rates may cause concerns, it is important to remember that you have options to help your clients in this environment.

This information is educational in nature and does not constitute a

FOR BROKER-DEALER USE ONLY. NOT FOR USE WITH INVESTORS.

financial promotion, investment advice, or an inducement or incitement

1—Bureau of Economic Analysis.

to participate in any product, offering or investment. It is not intended

and the PCE Price Index. 7/18/17.

to be used as a tool to determine your specific financial situation, tax

2—CNBC. Consumer Prices Jump

status, investment objectives, investment experience, suitability for any

Inflation Fears. 2/14/18.

specific investment, risk tolerance or investment profile. Resource is not

3—U.S. News and World Report. 4

adopting, making a recommendation for or endorsing any investment

Rising Inflation. 6/21/16.

strategy or particular security. The materials included herein are the

Resource Securities LLC, Member

property of Resource and may not be repurposed in a separate likeness

Comparing Price Measures—The CPI

Much More than Forecast, Sparking

Ways Investors Can Protect Against

FINRA/SIPC.

without the express written consent of Resource.

FALL 2018 AI QUARTERLY

9

Opportunity Zones Program: Qualified Funds and Related Tax Incentives

By Alan Lincoln, MBA, CCIM; Kyla M. Ehrisman, JD, MBA; Mick Law P.C. LLO

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Mick Law P.C., based in Omaha, Nebraska, is a specialty firm comprised of full-time and of-counsel attorneys who each possess a concentrated area of expertise and in-depth knowledge. While providing a broad range of legal services to valued clients, Mick Law focuses on two principal areas of practice; broker-dealer and registered investment advisor representation and real estate finance.

DEFINITIONS

The Opportunity Zones Program was created as part of the 2017 tax reform package (Tax Cuts and Jobs Act). Its goal is to drive long-term capital to distressed communities by providing tax benefits on investments in Opportunity Funds. The program will allow U.S. investors to receive a temporary tax deferral and other tax benefits when they reinvest unrealized capital gains into Opportunity Funds for a minimum of five years.

Opportunity Zone: A census tract which has been designated by the governor of its state as eligible to receive private investments through Opportunity Funds.

Opportunity Fund: A private investment vehicle, certified by the U.S. Department of the Treasury (the “Treasury”), to aggregate and deploy capital in Opportunity Zones for eligible uses defined as ‘Opportunity Zone Property.’

Opportunity Zone Property: Asset types eligible for investment under the Opportunity Zones Program. These include: stock in a domestic corporation; capital or profits interest in a domestic Partnership; and tangible property used in a trade or business of the Opportunity Fund that substantially improves the property.

Opportunity Zone Certification (IRC §1400Z–1) The Opportunity Zone Program uses low-income community census tracts as the basis for determining areas eligible for an Opportunity Zone designation. Per state or territory, up to 25% of the total number of census tracts that meet the eligibility requirements can be designated as an Opportunity Zone (i.e., if a state has 136 low-income census tracts, up to 34 may be designated as Opportunity Zones). States or territories with less than 100 low-income communities may designate up to 25 Opportunity Zones. Additionally, up to 5% of a state’s Opportunity Zones may be census tracts that are continuous to a low-income tract (subject to the median family income of the contiguous tract not exceeding 125% of the median family income of the low-income tract).

Opportunity Zones are designated by the governors of states and territories. Governors had 90 days from the enactment date of the program (which was December 22, 2017) to submit a list of designated census tracts for approval (the “Determination Period”). The Treasury must approve or provide feedback within 30 days of the governor’s submission (the “Consideration Period”). Both the Determination Period and Consideration Period can be extended for a

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The Opportunity Zone Program uses low-income community census tracts as the basis for determining areas eligible for an Opportunity Zone designation. Per state or territory, up to 25% of the total number of census tracts that meet the eligibility requirements can be designated as an Opportunity Zone.

period of 30 days. Opportunity Zone designations last for a period of 10 years (the “Designation Period�), at which point the certification process will take place again.

Governors had until March 21, 2018 to submit their recommendations for Opportunity Zone designations, unless the state requested a 30-day extension (to April 20, 2018). If a Governor failed to submit Zone nominations, that Governor would effectively be opting out of the program, rendering the state ineligible to receive private investment encouraged through Opportunity Zones tax benefits over the next decade.

On April 9, 2018, the Treasury designated Opportunity Zones in 15 states and 3 territories—issuing approvals for all states and territories that submitted Opportunity Zone nominations by the March 21 deadline. On April 19, 2018, five additional states

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and one territory had their nominations approved. An additional 25 states, Washington, D.C., and Guam had their nominations confirmed on May 18, 2018. Every eligible state and territory nominated census tracts for Opportunity Zones designation, and as of June 18, 2018, the final four states’ submissions were approved.

Opportunity Funds (IRC §1400Z–2) Opportunity Funds are a new class of investment vehicles (organized as a corporation or a partnership) that specialize in aggregating private investment and deploying that capital in Opportunity Zones to support Opportunity Zone Property. Opportunity Funds can be a partnership, corporation, or limited liability company. Investors receive either stock or an interest in the Opportunity Fund. The statute does not limit the number of funds that can be created, nor does it provide instruction on the nature of investments (i.e., risk/return profile).

Qualified Opportunity Funds are required to hold at least 90% of assets in qualified Opportunity Zone Property. The percentage of assets is measured twice yearly, “on the last day of the first 6-month period of the taxable year of the fund, and on the last day of the taxable year of the fund” (i.e., if a fund uses the calendar year as its taxable year, the dates of measurement will be June 30 and December 31). Funds that fail to meet the 90% standard are subject to penalties for each month in which they fail to meet the 90% standard. The penalty is “the amount equal to 90 percent of its aggregate assets, over (ii) the aggregate amount of qualified opportunity zone property held by the fund, multiplied by the underpayment rate established under [Code] section 6621(a)(2)” for each month a fund fails to meet the required threshold.

To become a Qualified Opportunity Fund, an eligible taxpayer self-certifies. Thus, no approval or action by the IRS is required. To self-certify, a taxpayer completes a form (which will be released in the summer of 2018) and attaches that form to the taxpayer’s federal income tax return for the taxable year. (The return must be filed timely, taking extensions into account.) Given the straightforward nature of statute requirements, it is unclear whether additional qualifications will be considered. The timeline for the availability of additional guidance is not yet known.

Tax Incentives (IRC §1400Z–2) If an investor realizes a gain from the sale or exchange of a capital asset to an unrelated party, the investor must invest in an Opportunity Fund within 180 days after the sale or exchange to be eligible for the program’s tax incentives. No upfront subsidy is provided to investors; all tax incentives are linked to the duration of the qualified investment. The provision has two main incentives: • Temporary deferral of inclusion in gross income for capital gains that are reinvested into Opportunity Funds. Investors are free to invest cash in Opportunity Fund investments in any amount; however, the portion an Opportunity Fund investment that is invested in excess of the capital gain amount is not eligible for the tax exemption.

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– Investors can roll existing capital gains into Opportunity Funds with no up-front tax bill.

– If investors hold their Opportunity Fund investments for five years, the basis of their original investment is increased by 10% of the amount of deferred capital gains (meaning they will only owe taxes on 90% of the remaining basis outside of rolled-over capital gains). If investors hold for seven years, the basis increases by a further 5% of the amount of deferred capital gains.

– Investors can defer their original tax bill until December 31, 2026 at the latest, or until they sell their Opportunity Fund investments, if earlier.

• Exclusion from taxable income of capital gains on Opportunity Fund investments held for at least 10 years. If an investor holds its investment in an Opportunity Fund for 10 years, the investor can elect to have the basis of the investment equal the fair market value of the investment as of the date of sale or exchange. In other words, after settling their original tax bill, investors in Opportunity Funds who maintain their investments for 10 years will face no capital gains taxes on their Opportunity Zone investments. As a final note, losses associated with investments in Opportunity Funds should be recognized as under pre-Tax Cuts and Jobs Act law.

As an illustration of an Opportunity Zone investment and the financial benefits associated making such an investment, we have outlined a sample ten year holding period making the following assumptions regarding the investment: Purchase Price:

$50,000,000

Load: 12.0% Investment Cost:

$56,000,000

Financing: $25,000,000 (4.4% Interest; 30 Year Amortization)

Rolled Over Investment

$31,000,000

Deferred Capital Gain

$15,500,000

Initial Investment Tax Basis

$40,500,000

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A summary of the cash flows generated by our sample investment over a ten year period are as follows:

2018

2019

2020

2021

2022

Year 1

Year 2

Year 3

Year 4

Year 5

$2,750,000 $1,502,283 $1,247,717

$2,818,750 $1,502,283 $1,316,467

$2,889,219 $1,502,283 $1,386,936

$2,961,449 $1,502,283 $1,459,166

$3,035,485 $1,502,283 $1,533,203

4.02%

4.25%

4.47%

4.71%

4.95%

Depreciation Interest Expense After Tax Income

$1,454,545 $1,375,000 -$79,545

$1,454,545 $1,375,000 -$10,795

$1,454,545 $1,375,000 $59,673

$1,454,545 $1,375,000 $131,904

$1,454,545 $1,375,000 $205,940

Income Taxes Due After Tax Cash Flow

$0 $1,247,717

$0 $1,316,467

$20,886 $1,366,050

$46,166 $1,413,000

$72,079 $1,461,124

Cash-on-Cash Return

4.02%

4.25%

4.41%

4.56%

4.71%

For the Years Ending

2023

2024

2025

2026

2027

Year 6

Year 7

Year 8

Year 9

Year 10

$3,111,373 $1,502,283 $1,609,090

$3,189,157 $1,502,283 $1,686,874

$3,268,886 $1,502,283 $1,766,603

$3,350,608 $1,502,283 $1,848,325

$3,434,373 $1,502,283 $1,932,090

5.19%

5.44%

5.70%

5.96%

6.23%

Depreciation Interest Expense After Tax Income

$1,454,545 $1,375,000 $281,827

$1,454,545 $1,375,000 $359,611

$1,454,545 $1,375,000 $439,340

$1,454,545 $1,375,000 $521,063

$1,454,545 $1,375,000 $604,828

Income Taxes Due After Tax Cash Flow

$98,639 $1,510,450

$125,864 $1,561,010

$153,769 $1,612,834

$182,372 $1,665,953

$211,690 $1,720,401

4.87%

5.04%

5.20%

5.37%

5.55%

For the Years Ending

Annual Income NOI Financing Cash Flow Cash-on-Cash Return

After Tax Cash Flow

Annual Income NOI Financing Cash Flow Cash-on-Cash Return

After Tax Cash Flow

Cash-on-Cash Return

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Given the uneven cash flows associated with the tax benefits of an Opportunity Zone investment, we believe the most appropriate return metric is an internal rate of return (IRR) calculation. Below is a summary of the applicable after-tax cash flows if investing into the same investment both WITHIN an Opportunity Fund and OUTSIDE an Opportunity Fund:

A summary of applicable after-tax cash flows if investing into the same investments OUTSIDE an Opportunity Fund.

2018

2019

2020

2021

2022

Year 1

Year 2

Year 3

Year 4

Year 5

Cash Flows $1,247,717 After Tax IRR (5 Year Sale) 2.57%

$1,316,467

$1,366,050

$1,413,000

$29,504,339

Cash Flows IRR (10 Year Sale)

$1,247,717 5.76%

$1,316,467

$1,366,050

$1,413,000

$1,461,124

2023

2024

2025

2026

2027

Year 6

Year 7

Year 8

Year 8

Year 10

$1,510,450

$1,561,010

$1,612,834

$1,665,953

$36,907,696

For the Years Ending

Outside an OZ

For the Years Ending

Outside an OZ Cash Flows After Tax IRR (5 Year Sale) Cash Flows IRR (10 Year Sale)

As is indicated above, the IRR if investing under the parameters outlined above into a property which is OUTSIDE an Opportunity Fund would be 2.57% over a five-year period or 5.76% over a ten-year period.

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The IRR if investing under the parameters outlined below into a property which is WITHIN an Opportunity Fund would be 2.76% over a five-year period or 6.76% over a ten-year period.

A summary of applicable after-tax cash flows if investing into the same investments WITHIN an Opportunity Fund.

2018

2019

2020

2021

2022

Year 1

Year 2

Year 3

Year 4

Year 5

Cash Flows $1,247,717 After Tax IRR (5 Year Sale) 2.76%

$1,316,467

$1,366,050

$1,413,000

$29,814,339

Cash Flows IRR (10 Year Sale)

$1,247,717 6.76%

$1,316,467

$1,366,050

$1,413,000

$1,461,124

2023

2024

2025

2026

2027

Year 6

Year 7

Year 8

Year 8

Year 10

$1,510,450

$1,561,010

$1,612,834

-$969,047

$44,205,416

For the Years Ending

Within an OZ

For the Years Ending

Within an OZ Cash Flows After Tax IRR (5 Year Sale) Cash Flows IRR (10 Year Sale)

Conclusion Using our hypothetical investment as outlined above, over a five year holding period, an investment in an Opportunity Fund-held property has an IRR that is 19 basis points higher than if the same property were held outside of an Opportunity Fund (2.76% IRR versus 2.57% IRR). Looking at the same hypothetical investment with a ten year holding period, the IRR spread between the two investment scenarios increases to 100 basis points (6.76% IRR for an Opportunity Fund investment, 5.76% IRR for a non-Opportunity Fund investment).

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SEC Proposes “Regulation Best Interest” Rule Package

By John Grady, Edward J. Johnsen, Bradley E. Phipps DLA Piper

The Securities and Exchange Commission held an open meeting on April 18, 2018, during which the Commissioners voted 4 to 1 to release a package of rules, forms and interpretations for public comment designed to “enhance the quality and

• establish a best interest standard for broker-dealers • create a mandatory disclosure form summarizing brokers’ and investment advisers’ relationships with their clients and • offer a new official interpretation affirming and clarifying the standard of conduct for investment advisers.

transparency of investors’ relationships

The proposals would also restrict brokers from using the titles “advisor” or “adviser” in certain contexts and/or communications.

with investment advisers and broker-

Best interest standard

dealers” and to introduce a new disclosure

The proposal would require a broker-dealer to act in the best interest of its retail customers when making a recommendation of any transaction or investment strategy involving securities,

form for use with retail customers.

18

Divided into three primary parts, the rule and guidance package would, among other things:

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John Grady (ADISA’s Immediate Past President), Edward Johnsen and Bradley Phipps are all members of DLA Piper’s Investment Management team. DLA Piper’s Investment Management practice combines breadth of knowledge across multiple statutes and regulations—principally the Investment Company and Investment Advisers Act, along with the Securities Exchange Act—with real, hands-on industry experience to give fund sponsors, managers and distributors timely guidance and assistance.

broker-dealers would be required to disclose their registration status with the SEC.

without putting its own interests ahead of the customer. The broker-dealer’s compliance obligations under this new standard would be judged by three criteria—disclosure, care and conflicts of interest. As proposed:

Interpretation of an investment adviser’s fiduciary duty

• Broker-dealers must disclose key facts about the customer relationship, including conflicts of interest. Importantly, and unlike the Department of Labor’s fiduciary rule, such conflicts of interest are not banned outright.

Commissioner reactions

• Broker-dealers must exercise reasonable diligence, care, skill and prudence to (i) understand the product; (ii) have a reasonable basis to believe it’s in the customer’s best interest; and (iii) have a reasonable basis to believe that a series of transactions is in the customer’s best interest.

• Broker-dealers must establish, maintain and enforce policies and procedures reasonably designed to identify, and, at a minimum, disclose and mitigate material conflicts of interest arising from financial incentives. Other material conflicts must also be disclosed.

Form CRS The proposal would require investment advisers and brokerdealers, and certain of their investment professionals, to provide a standardized disclosure document—a client relationship summary (Form CRS)—that would address the nature of the customer relationship with them. The fourpage form would provide a summary of the relationship with retail customers, as well as supplement other more detailed disclosures. It would highlight key differences in the principal types of services offered—eg, advisory versus brokerage— legal standards of conduct that apply, fees a customer may have to pay, and certain conflicts of interest.

Restriction on the use of “adviser” or “advisor” Under the proposal, broker-dealers and financial professionals may be restricted from using the terms “adviser” or “advisor” as part of their title with retail investors. Additionally, in certain communications with retail investors, investment advisers and

The proposal includes new interpretative guidance that is intended to reaffirm and clarify the SEC’s views as to certain aspects of the fiduciary duty that investment advisers owe their clients.

All of the SEC Commissioners stated that the proposal needs more work. Commissioner Kara M. Stein opposed the proposal as failing to provide enough protection and not going far enough in policing broker-dealers, maintaining that it effectively maintains the status quo. Commissioners Robert J. Jackson, Jr. and Hester M. Peirce said they were merely supporting issuing the proposal for public comment, withholding support for the proposal itself. In that regard, Commissioner Jackson said he generally supported the DOL’s rulemaking effort and was reluctantly voting to put the proposal out for public comment, while Commissioner Pierce said that she had concerns about the clarity of the standards proposed; she said that she disagreed, however, with those who claimed that “the emperor had no clothes.” Based on the initial reaction of the Commissioners, it is unclear how the Commissioners might ultimately vote on any final rules or guidance.

What’s next?

The proposal is open for comment during the 90-day period following publication in the Federal Register. If enacted, the rule could replace the Department of Labor’s fiduciary rule. That rule was vacated by the Fifth Circuit Court of Appeals last month and remains under review, as directed by President Trump.

In general, the proposal appears to seek to heighten the duties applicable to broker-dealers, but does little to impact the current rules applicable to investment advisers other than the potential requirement to deliver the Form CRS to retail clients.

We are actively reviewing the SEC’s nearly 900-page proposal and expect to provide commentary on the proposal during the comment period.

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Solving Your Talent Management Problem and Increasing Your Business by 40%

By Deborah S. Froling, Partner, Kutak Rock LLP

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Froling has extensive experience in public and private offerings of debt, equity and convertible securities as both issuer’s and underwriter’s counsel primarily for real estate companies. She has closed public and private debt and equity offerings, primarily for REITs and other real estate companies, as well as non-traded equipment finance and oil and gas companies, and business development companies. She has also structured and closed numerous tenant-in-common syndications, and has worked with public and private company clients providing general corporate counseling and advising on periodic and annual report and other SEC disclosure requirements.

In U.S. households with children under the age of 18, women are the sole or primary breadwinners in 40% of them and in the median household where a mother is working outside the home, women contribute nearly 40% to the family’s total earnings.1 Women account for 85% of all consumer purchases, determine 89% of decisions on bank accounts and own 40% of stocks. In addition, 84% of women feel misunderstood by investment marketers and 70% of new business are started by women. 2

Statistics don’t lie. Companies that are better in gender diversity within their executive teams were more likely to outperform on profitability and value creation. Diversity in management teams leads to better decisions, less group think and the ability to see issues from many angles.3 If financial services firms do not focus on attracting and keeping women both as employees and as clients, they will not only fail to thrive, but may fail to survive.

Imagine not addressing the needs of 40% of your clients or only recruiting from 60% of qualified candidates. Sounds like a recipe for failure. Could your firm survive on 60%? Maybe, but the long-term implications of that reduction would be significant. If firms want to expand their market to the other 40% of financial decision makers, having a workforce that resembles that demographic is important.

Women continue to be underrepresented in the workforce at all levels and as careers advance from entry level to upper management, the disparity only grows larger. Women generally make up approximately 20% of employees at the executive level and only 35% at the professional level and above.4

Women continue to be underrepresented in the workforce at all levels and as careers advance from entry level to upper management, the disparity only grows larger.

In financial services firms, the gender breakdown is similar.5

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Women

Hires

Men

Current Exits Hires composition

Current composition

Exits

Executives

3.5%

15%

15.8%

4.8%

85%

7.7%

Senior Managers

5.4%

26%

8.8%

5.3%

74%

7.7%

Managers

4.8%

37%

8.4%

5.9%

63%

7.6%

Professionals

10.8%

46%

10.5%

12.6%

54%

11.3%

Support Staff

12.3%

67%

13.1%

18.8%

33%

13.4%

However, at the executive level, women are hired at a lower rate than men (3.5% versus 4.8%) and leave at double the rate of men—15.8% versus 7.7%. One sobering fact noted by Forbes—“if there is only one woman in your candidate pool, there’s statistically no chance she’ll get the job.”6 (Emphasis added).

Along with lower hiring rates for women versus men, promotions are also lagging behind in financial services firms. This leads to what is referred to as the “leaky pipeline” and it has significant implications not only for the women, but for their families and the companies they leave. Why women leave is as varied as the jobs they leave but Forbes notes that “90% of women leave because of other workplace problems (rather than having a child).”7 As noted above, women are still significant contributors to the income of their households. They are starting

There are significant costs to employers to replace those women who leave.

Their departure causes disruption in the business of the firm and the firm has to incur additional costs to replace, retrain and develop new employees.

their own businesses at a rate two and a half times the national average. There are 11.6 million women owned businesses in the U.S. which employ approximately nine million people and generate $1.7 trillion in revenue.8 There are significant costs to employers to replace those women who leave.

While entry level employees are paid the least, it takes time and energy to train them, integrate them into the organization and introduce them to clients—all with an eye toward promoting them and counting on them to generate revenue.

Spending all that time and energy training them to have them walk out the door at the time when they start to pay dividends is a bad business model and makes little economic sense. Their departure causes disruption in the business of the firm and the firm has to incur additional costs to replace, retrain and develop new employees.

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In fact, the “gender gap”—with respect to labor, market opportunity, education, health and political clout, will continue. The World Economic Forum projects that gender parity will not be achieved globally for 170 years and in North America, 158 years. That’s five generations until there is gender equality.9 That is too long to wait.

Driving success in the future will require skills like “flexibility/adaptability to change, inclusive team management, problem-solving, innovation and creativity.”10 Mercer’s research suggests that “female managers may have a higher prevalence of these emerging competencies, whereas male managers have relative strengths in strategic visioning, technical expertise, P&L management and entrepreneurship.”11 The representation of women (and minorities) is inadequate in our industry and others as well. As an industry trying to appeal to a changing demographic, we need to do better. We need to open the tent and allow more folks into it. We need to do it in a strategic and mindful way. It is said that “what gets measured, gets done.” In order to solve the gender gap, financial services firms must focus on it. Mercer’s key findings and recommendations include:

1. Engage leaders, managers and men; 2. Actively manage flexible work programs; 3. Focus on filling the entire talent pipeline and understanding the skills and experiences necessary for advancement; 4. Review processes for potential bias; and 5. Develop a holistic strategy that addresses women’s unique needs.

With respect to engaging leaders, managers and men, this is not a “women’s” problem, it is a talent management problem and we need men as allies to help solve it. Given that 85% of executives in financial services firms are men, we need to enlist and teach men how to think about diversity in a different way. We need them to recognize that there is a solid business case for diversity, its effect on the business, the resources, profitability and adaptability to changing demographics and decide that this is good for business. We need to make men focus on the talent inside their organizations, identify those who have the skills and acumen to advance and focus on retaining and promoting those talented people in a mindful and strategic manner.

Family friendly policies are good for businesses and most firms have some kind of flexible

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Pipeline issues are important if women are ever going to increase their representation at the top levels of management. If women are not filling P&L roles, and that’s where CEOs are recruited from, then the lack of women CEOs is going to continue.

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work programs, including parental leave policies and flexible schedules. What is lacking, however, is training for managers to support employees throughout a parental leave and then returning to work as well as how to identify and overcome potential bias in rewards and promotions following these leaves.12 Pipeline issues are important if women are ever going to increase their representation at the top levels of management. According to Mercer, financial services firms “need to focus on systemic, supporting practices to build the female talent pipeline that will sustain gender equality in the long term.”13 Mercer suggests that this means “increasing the prevalence of women in profit and loss roles.”14 According to their research, only 26% of financial services firms agree that there is equal representation of men and women in profit and loss roles. Women executives tend to be clustered in audit, legal, compliance or marketing or HR roles, but CEOs are typically recruited from P&L roles, such as major business units.15 If women are not filling P&L roles, and that’s where CEOs are recruited from, then the lack of women CEOs is going to continue.

Unconscious bias can be overcome where an organization has a robust pay equity process and a dedicated pay equity team with a greater female representation.

However, Mercer found that only 32% of financial services firms review performance ratings by gender and pay equity adjustments as part of an annual compensation review process is only done by 26% of them.16 Applying a gender lens to pay, promotion and performance management processes will help alleviate the disparity that still exists and will help overcome those existing unconscious biases.

Financial services firms need to focus on gender specific investing strategies and

Applying a gender lens to pay, promotion and performance management processes will help alleviate the disparity that still exists and will help overcome those existing unconscious biases.

programs for their female clients and employees. Because women make less than men, have more gaps in their employment and live longer than men, they need retirement funds to last longer and may not have participated in employer sponsored plans for as long as men. Women are also usually more risk-averse investors than men so that they will seek lower returns for the safety of principal. Therefore, they need different investing strategies to take these factors into account. According to Mercer, less than 15% of financial services firms offer retirement programs on a gender-specific basis to address these differing needs.

17

Obviously, these kinds of

programs are not required for everyone; however, understanding and focusing on the differences between men and women and their investing profiles and needs should be taken into account when making financial decisions for the long-term.

When organizations do not shine a light and try to reach all of those people who are making the financial and investing decisions in a household, when they do not hire,

1—Why We Need Gender Equity Now, Katica Roy, ForbesWoman, September 14, 2017 (“Forbes”).

2—She-conomy.com/facts-onwomen. Accessed September 9, 2018.

3—Group of Thirty, Banking Conduct and Culture: A Call for Sustained and Comprehensive Reform, July 2015.

4—When Women Thrive: Financial Services Perspective, October 2016, Mercer (“Mercer”), at page 1.

5—Mercer at page 5.

6—Forbes at page 3.

7—Id. 8—State of Women-Owned Businesses Report, American Express.

9—Forbes at page 3.

train and promote people who look like those in their communities, when they do not

10—Mercer at page 4.

focus on the skills necessary to advance in their field and provide those opportunities

12—Mercer at page 9.

11—Id.

equally to all qualified candidates, those organizations may continue to plod along but

13—Mercer at page 10.

they will start to fall behind and perhaps not thrive or survive. The world is increasingly

15—Id.

diverse, and all firms must learn to adapt to these changing demographics and

17—Id.

14—Id .

16—Mercer at page 11.

workforce needs.

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ADISA

News

Events

ADISA 2018 Alternative Investments Research & Due Diligence Forum Wrap-Up ADISA 2018 Annual Conference & Trade Show Preview

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2018 AI RESEARCH & DUE DILIGENCE FORUM JULY 10-11 • NEW YORK HILTON MIDTOWN

ADISA’s 2018 Alternative Investments Research & Due Diligence Forum WRAP-UP This past July, ADISA hosted its most successful Alternative Investments Research & Due Diligence Forum to date, welcoming approximately 260 broker-dealers, RIAs, family offices, sponsors & affiliates to the New York Hilton Midtown in Manhattan.

The agenda focused on topics that are both critical and timely to the alternative investment industry, including a real estate update from real estate leaders; a legislative & regulatory update; new alternative products and opportunities, such as Opportunity Zones; a real-life 1031 tax demo; and much more.

Keynote speaker Bob Rice, Tangent Capital Partners, presented a broad view of the function, portfolio design and options for various alternatives in our space for the wisest investment.

ADISA continues to build on the success of its events—mark your calendars for our Annual Conference & Trade Show, October 8-10 at the ARIA Resort & Casino, Las Vegas.

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Join us for the premier education and networking event for the alternative & direct investment industry, where the sharpest minds in the business will convene for three

Johnson

Keynote Speaker Magic Johnson is a five-time

days in Las Vegas. ADISA’s

NBA champion and three-time

Annual Conference & Trade

league MVP, who is currently

Show in the leading forum for

chairman of Magic Johnson

gathering the latest product

Enterprises and president of

information, staying on top

basketball operations with the

of industry trends, conducting

Los Angeles Lakers. Join us to

due diligence and more.

Attendee Breakdown 1000+ Attendees Expected 75+ Exhibitors

28

Earvin “Magic”

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hear about his tremendous career and entrepreneurial success.

As of 9/10/18; subject to change

Monday October 8 2:00-3:00 pm (1) Fundamentals of Alternative Investments (2) 1031 Exchange Fundamentals (3) Real Estate Outlook: Office, Retail, Industrial (4) Energy 2018-2019: The Awakening of an Almost Forgotten Asset Class 3:10-4:15 pm (5) Advanced Principles of Alternative Investments (6) Real Estate Outlook: Multifamily, Students, Seniors, Hospitality (7) Debt Offerings: What to do in an Increasing Interest Rate Environment?

Is There Still a Place for Bonds?

(8) Conservation Easements Fundamentals 4:30-5:00 pm Conference Kick-Off 5:00-6:00 pm General Session I: Industry Update 6:00-7:00 pm Cocktail Reception & Exhibition

Tuesday October 9 8:00-9:00 am Breakfast & Exhibition 9:00-9:50 am General Session II: Legislative & Regulatory Update – Part I 10:00-10:50 am (9) Late-Breaking New Product Investigation (10) DST Investing by Property Type (11) REITs in the Modern Age (12) RIAs: How to Incorporation Alternatives in Portfolios, Commissions & Fees 11:00-11:50 am (13) 2017 Tax Reform (14) 1031 Tax Reporting and Full Cycle Events (15) BDCs are Trending Due to Tax Reform… Should You Get on Board Again?

(16) Energy & Conservation: Contrasting the Program Features, Benefits & Risks 12:00-1:45 pm Lunch & Exhibition

1:45-2:35 pm (17) What is Driving Interval Funds and Who is at the Wheel?

(18) Purchasing & Servicing Alternatives for RIA Firms (19) DST Tech: Debt/Master Tenants & Buyouts (20) Reg D & Reg A Offerings: How They Compare and When to Use Which Structure

Thank You to our Diamond & Platinum exhibitors DIAMOND

2:45-3:35 pm (21) Opportunity Zones 101 (22) Expanding 1031 Business for Reps (23) Sponsors & Broker-Dealers: SEC Advertising Rules (24) To Be Preferred or Not to Be Preferred?

3:35-4:00 pm Break & Exhibition 4:00-4:50 pm (25) REITs in Advisory Accounts: What Are the Options and What do Sponsors, Broker-Dealers and RIAs Need to do to Make it Work?

(26) Opportunity Zones: Offerings & Structures (27) Private Equity: Is Smart Money the Right Fit for Retail Investors?

(28) Making Progress with Automation

PLATINUM

5:00-6:00 pm General Session III: Legislative & Regulatory Update – Part II 6:15-7:15 pm Cocktail Reception & Exhibition

Wednesday October 10 7:30-9:00 am Breakfast & Exhibition 9:00-10:00 am General Session IV: Keynote Speaker Earvin “Magic” Johnson 10:10-11:00 am (29) Broker-Dealer Advisory Council (30) Better Understanding Risk in REITs (31) Marketing Ideas for Sponsors in Today’s Market: Tips and Tricks 11:10 am-12:10 pm General Session V: Bob Rice

GO TO

adisa.org/events/ 2018-annual-conference/exhibit-hall TO VIEW ALL EXHIBITORS.

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10401 North Meridian Street Suite 202 Indianapolis, IN 46290

ADISA 2019 Spring Conference April 1-3 Marriott San Antonio Rivercenter

ADISA 2019 AI Research & Due Diligence Forum

ADISA 2019 Annual Conference & Trade Show

July 17-18

October 14-16

The Mayflower Hotel Washington, D.C.

The Cosmopolitan of Las Vegas

SAVE THE 2019 DATES adisa.org 30

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