As we have noted in earlier posts, the SEC has had increased authority over the private equity industry since Dodd-Frank was passed in 2010. Several years ago, an SEC official remarked that SEC exams “identified what we believe are violations of law or material weaknesses in controls over 50% of the time” (see below for link to quote). Not surprisingly, the Office of Compliance Inspections and Examinations of the SEC identified the examination of private fund advisors, with a focus on fees and expenses, as a priority for 2016.
In order to prepare for an audit by the SEC – whether one seems remote or inevitable – private equity firms can do the following:
- Develop a strong compliance program – the hallmarks are an engaged management team, active and involved compliance officers/department, and having devoted sufficient resources to implement a customized program (both on the front end, and when potential issues arise).
- Disclose, disclose, disclose – this means that, among other things, all fees and expenses must be accurately and adequately communicated to investors up front, and valuation methodologies, investment strategies, and mechanisms for dealing with conflicts of interest should all be clearly described in limited partnership agreements.
- Demonstrate – conducting regular self-audits can highlight issues before they become problems and gives firms the opportunity to respond to SEC actions and guidance as they are issued, which makes maintenance both manageable and relevant.
For additional insight, see the speech given by former SEC Director of the Office of Compliance Inspections and Examinations, Andrew J. Bowden at https://www.sec.gov/news/speech/2014–spch05062014ab.html.