In 2020, Mark Hauser reported that the global venture capital investment market, a subset of private equity, reached a value of $19.7 billion. Experts predict that from 2021 to 2026, the industry will grow at a compound annual growth rate (CAGR) of 16%. The rapid growth experienced by the industry has raised concerns for the U.S. Securities and Exchange Commission (SEC), causing the government agency to introduce 11 new proposals to tighten regulations. In response, according to Massachusetts Institute of Technology (MIT) research reports, private equity firms have turned to investing heavily in regulatory compliance, or “RegTech,” to help them “stay compliant, avoid sanctions, and measure financial risk more precisely.”
RegTech “uses information technology to achieve regulatory compliance and enables improved record-keeping, better data management, and more robust reporting solutions.” RegTech stretches across all industries, including banking, retail, gaming, technology, healthcare, and financial services. The objective of RegTech is to support consistency and transparency within those industries while standardizing regulatory processes and ensuring accurate interpretation of regulations.
Commenting on the current RegTech environment and the key factors contributing to its rise is Mark Hauser, a private equity investor, and fund manager with more than 35 years of investing and operating company experience. Mark Hauser is the founder and co-managing partner of Hauser Private Equity (HPE), a firm that invests in private equity funds and directly in privately owned businesses. The firm’s four funds have invested more than $300 million in capital in privately owned businesses across a diverse set of industries nationwide.
Reducing Cybersecurity Risks
According to the SEC, “Advisers and funds play an important role in our financial markets and increasingly depend on technology for critical business operations. Advisers and funds are exposed to and rely on a broad array of interconnected systems and networks, both directly and through service providers such as custodians, brokers, dealers, pricing services, and other technology vendors. As a result, they face numerous cybersecurity risks and may experience cybersecurity incidents that can cause or be exacerbated by the critical system or process failures.”
Due to the nature of the relationship between financial markets and technology, “the Securities and Exchange Commission [has] proposed new cybersecurity risk management rules and amendments to enhance cybersecurity preparedness and improve the resilience of investment advisers and investment companies against cybersecurity threats and attacks.
Specifically, the proposal would:
- Require advisers and funds to adopt and implement written policies and procedures that are reasonably designed to address cybersecurity risks;
- Require advisers to report significant cybersecurity incidents to the Commission on proposed Form ADV-C;
- Enhance adviser and fund disclosures related to cybersecurity risks and incidents; and
- Require advisers and funds to maintain, make, and retain certain cybersecurity-related books and records.”
Leveraging RegTech in response to the SEC’s proposed rules and amendments is one way private equity firms can combat the increased risk of cybercrime, which is projected to cost the country an estimated $10.5 trillion annually by 2025. It also allows them to meet the requirements of the newly introduced standardized due diligence questionnaire, monitored by the Institutional Limited Partners Association (ILPA), a global organization dedicated to supporting the interests of limited partners. A due diligence questionnaire is a formal assessment made up of questions designed to outline the way a business complies with industry standards, implements cybersecurity initiatives, and manages its network.
In addition to this, Mark Hauser suggests that private equity firms take specific actions in response to increased cyber risks. Citing the SEC’s “reasonable designed approach to managing cyber risk,” he advises private equity firms to develop strategies based on the following characteristics:
- Informed: The strategies that private equity firms choose to implement should support and promote an awareness of today’s cyber risks, including regulatory and legal considerations.
- Manageable:If firms choose to do a risk evaluation, they should do it in a manner that is manageable and does not overwhelm the business or negatively impact day-to-day operations.
- Digestible: Private equity firms should write reports “in plain English,” so leaders, including the chief operating officer (COO), deal teams, and board of directors, can easily consume the information.
- Actionable: Firms should also focus on writing clear reports that include reasonable next steps to address key cyber risks that have been identified.
Taking a proactive approach like this can ensure that private equity firms reduce the risk of a cyber-attack and that all of their data remains confidential.
The Impact on Cryptocurrency
Outside of the SEC’s proposed rules and amendments to reduce cybersecurity risks, investors should follow recommendations for increased regulation of cryptocurrency. According to investor Mark Hauser, such guidelines could be beneficial for investors. In fact, he supports theories that have been previously outlined by NextAdvisor.
Currently, cryptocurrency has been affected by minimal regulations, which has prompted a lot of discussion among politicians in Washington D.C.
“Recent conversations on Capitol Hill suggest [that] it’s not a matter of if further regulation is coming, but when. President [Joe] Biden signed off on new crypto legislation related to taxes in the $1.2 trillion bipartisan infrastructure bill late last year. And the Federal Reserve is toying with the idea of issuing a U.S. digital currency.”
Crypto investors looking to abide by this new law need to keep two things in mind. First, they need to keep track of their cost basis – what they originally paid for the crypto – as accurately as possible to reconcile with what exchanges will report to the Internal Revenue Service (IRS). Second, they need to find a crypto-knowledgeable tax professional who can accurately report their crypto investments. They need to be as transparent as possible with regard to what cryptocurrency they hold and what they paid for it.
Although resistance to such regulations exists, they can lead to a more stable trading market, an increase in investor protection and confidence, and a safer crypto ecosystem. As Mark Hauser acknowledges, the current state of cryptocurrency is volatile, and investors are encouraged to limit their investment portfolio to less than 5% of crypto. Until more regulations are in place, the crypto trading scene is likely to remain risky – both in terms of financial loss and cyber-attacks – for investors.
The Rising RegTech Industry
Increased regulations are not the only factor that has contributed to the growth of RegTech, according to Mark Hauser. Additional factors, which have been building since the 2008 financial crisis, have impacted the situation. For example, the emergence of new digital habits among American consumers and the rising number of fraudulent financial activities have both played a role.
The demand for RegTech will continue to rise as consumer reliance on digital platforms increases, and private equity firms remain the target of cyber threats and attacks. Investing in the right technology now can help private equity firms preserve their brand and keep their trading portfolios confidential well into the future.
Amidst this shift, investors can also benefit from increased deal activity in the sector. Mark Hauser, whose firm does not currently invest in RegTech, predicts that the industry will continue creating powerful products, and, despite the decline in activity in 2020, the response to current global trends will increase the number of opportunities available to investors in the sector.
Chris Steele, director of risk and regulation banking at KPMG, reports, “We expect a continuation of the trend that has seen those RegTech firms receiving more investor attention at this time, offering solutions for COVID-19-related needs, such as identification and management of vulnerable customers, fraud detection, or complaint management.”
About Mark Hauser
Mark Hauser is the managing partner at Hauser Private Equity, a fund manager for private equity clients. The firm is a continuation of Hauser Capital Partners’ (HCP) successful strategy of directly co-investing throughout the lower-middle and middle markets via partnerships with control buyout funds and selectively with managers of growth equity and special situation funds. Hauser Private Equity’s four funds have invested more than $300 million in capital in privately owned businesses across a diverse set of industries in the United States.
Mark Hauser earned a bachelor of business administration (BBA) degree from Miami University. Prior to founding Hauser Private Equity, Mark Hauser held the position of vice president at Reynolds, DeWitt & Co., a privately owned business involved with S-corporations and multiple partnerships. He has also served on the board of directors for consumer goods and food and beverage brands and on boards for government-contracted security, defense businesses, and digital advertising and textile manufacturing corporations.