GC, CCO roles can protect PE firms as SEC steps up AI scrutiny

Private equity has been quick to use AI in its efforts to achieve better investment outcomes. That makes it imperative that PE firms structure their legal and compliance operations to account for the aggressive approach the Securities and Exchange Commission has taken in its regulation of the new technology.  

In addition to its marketing and private fund advisors rules, both of which have been used in connection with AI oversight, the agency has a robust rulemaking agenda on the horizon that includes regulation around cybersecurity and ESG.

These actions mean PE firms will need to have dedicated internal resources in place — their own watchdogs, in the form of a general counsel and chief compliance officer — to advise their teams and their portfolio companies on using AI. These watchdogs will have responsibility for ensuring that PE firms deploying AI are not jeopardizing their businesses by crossing legal and regulatory boundaries and taking on excessive risk. 

Internal safeguards

The level of support a PE firm needs will vary based on the scope and depth of its business model. Although PE firms often have a general counsel that handles both legal and compliance, it can make sense to separate the roles and have a GC and CCO, if a firm can support that structure.

While both roles share a common goal of ensuring the firm’s legal compliance, they perform distinct functions. A GC provides legal advice and counsel, while the CCO oversees compliance with laws, regulations, policies and procedures.

Separating the roles will allow the GC to ensure that legal risks are properly assessed, mitigated and managed, while the CCO focuses exclusively on compliance matters without being influenced by legal considerations.

What to look for

When setting up a structure like this, firms should be looking for legal and compliance leaders who understand the private equity landscape. This background will enable them to assist their firms’ pursuit of key business goals, while intelligently evaluating all possible courses of action, managing risk and protecting the firm’s reputation.

If the roles of GC and CCO are separated, effective compliance leaders in PE should be well-versed in the Investment Advisers Act of 1940, experienced with managing SEC examinations, and have intimate familiarity with PE firm operations, as well as a demonstrated track record of implementing formal compliance programs in the PE space. Meanwhile, the GC in PE should have expertise in fund-related matters, including fundraising and fund formation, investment and transaction-related matters, and also should be able to provide strategic counsel and act as a legal advisor to management on a broad range of issues across fund formation, regulatory, fiduciary, risk and other general corporate matters. The GC and CCO should work closely together to ensure firm-wide compliance with all applicable legal and regulatory requirements. (If the GC and CCO role is merged, successful leaders should be able to straddle both legal and compliance responsibilities).

The firm will also want leaders who are business-oriented, but willing to think outside of the box. Any C-suite-level leader should have strong business acumen to be able to understand how the actions within their function impact the organization as a whole and vice versa. General counsel and CCOs should be naturally forward-looking, scanning the horizon and staying three steps ahead to effectively address gray areas with an eye toward practicality, able to identify significant emerging compliance trends, while also ensuring compliance and alignment with the firm’s values. They should be able to think on their feet, using strong analytical and problem-solving skills and providing practical solutions.

In addition, these PE legal and compliance leaders will need to be nimble, curious, comfortable with change and living in ambiguity. These “soft skills” cannot be overlooked. They should possess excellent communication (both written and verbal) and interpersonal skills, with the ability to collaborate well across functions as new technologies evolve and as the regulatory regime strengthens.

PE firms should also consider building a strong bench at the junior level to support the legal and compliance leaders at the C-suite-level. Junior level in-house resources can help tackle the day-to-day legal and compliance needs of the business, but can also dedicate time to minimizing risk and ensuring compliance with new and future SEC regulations in an efficient and cost-effective manner, also reducing the workload for the GC and CCO, allowing them to focus on high priority matters. Investing in a strong legal and compliance team across functions will build manpower and a bank of institutional knowledge that is certain to pay dividends later.

With the surge of new regulations and proliferation of the use of AI, PE firms need to arm themselves with adequate internal resources and build appropriate infrastructure to deal with these regulations and those that are certain to follow. Federal regulators and watchdogs are watching PE firms and the financial industry with a very careful eye as it relates to the use of AI. Bringing the roles in-house will offset the rising costs of retaining outside counsel and compliance consultants and make access to this expertise readily available as situations arise. The best general counsel and chief compliance officers will know how to adeptly stay ahead of the curve and manage the legal, compliance and risk implications of AI thoughtfully and strategically allowing PE firms to fully use this technology while staying clear of outside scrutiny.