Early Signs of a Significantly More Expansive Approach to SEC Examinations of Private Markets Fund Managers

Author

Vivek Pingili

Publish Date

Type

Article

Topics

  • Compliance

While it is too early to characterize as a trend, in Q2 2021, we started to see early signs of a significant expansion in the scope of Securities and Exchange Commission (SEC) exams involving private markets fund managers. For example, we have started to see the cover period for SEC exams extend up to 5 years (as opposed to the more typical 1-3 years seen during the Clayton administration) and initial document request lists comprising of 90+ items (as opposed to the more typical 20-30 items seen during the Clayton administration). The document production deadline we have seen in these more expansive versions of SEC exams continues to remain fairly compressed (typically 10 to 14 days) in an effort to stress test firms.

These newer exams, while constituting a small minority of current overall exam activity, only serve to further illustrate the critical importance for private markets firms to be well prepared for future exams (no matter how robust) by undertaking periodic mock exam exercises based on the most recent SEC document request lists in circulation at any given time.

Many of the SEC requests in these more comprehensive exams continue to remain similar (if not identical) to what we have seen in the past. However, as listed below, there are several noteworthy requests that are either new or variations of existing focus areas. In connection with ensuring they are SEC-exam ready, private markets firms should carefully review this list – both to undertake a gap analysis as well as to ensure they are in a position to quickly and efficiently gather and produce the requested documentation.

Resignations/Terminations – Affirm whether any former supervised person filed or stated complaints against the firm or its employees, alleging actual or potential violations of securities laws as the cause for the resignation or termination.

Client/Investor On-Boarding and Portfolio Analysis Presentations – A representative example of any materials presented to clients or investors in one-on-one meetings prior to becoming a client/investor, or during the onboarding process, pertaining to 1) obtaining information on client objectives, risk tolerance, and suitability; 2) verifying qualification to be a private fund investor; and 3) recommendations or analysis on the client’s portfolio; along with any scripts or guidelines that supervised persons follow during these meetings.

Private Fund Extensions

  • Communications sent to LPs/LPAC in connection with seeking approval for extending a private fund’s term
  • Details around any LPs who did not approve such an extension request
  • Details around the use of third parties to assist with obtaining extension approvals

Customized Performance Reporting - Details around information requested by, and provided to, specific LPs relating to a private fund’s performance and copies of any other type of customized Fund performance information provided to specific LPs (e.g., pursuant to a side letter provision).

Private Equity Due Diligence - A description of the Adviser’s process for conducting and documenting initial due diligence and ongoing oversight of the portfolio companies held by the Private Funds (and/or reference to relevant policies and procedures provided in response to a previous request). The firm should provide a copy of any due diligence checklists and/or policies and procedures, including ESG-related, that are used in the due diligence process.

Note: While the SEC’s push for more formalized approaches to investment due diligence in the private markets fund industry is not new, the inclusion of such a request in an initial request list is relatively new. Additionally, it is noteworthy that the SEC has started to enquire about ESG-related investment due diligence in mainstream exams (as opposed to solely in ESG-focused exams). This is another sign that, as in the case of cybersecurity, the SEC’s ESG focus is increasingly becoming a staple part of examinations in the private markets fund industry.

Private Fund Management Fees - Details around any changes to a private fund’s management fee structure implemented during the past four years and whether management fees were charged on any fund audit holdbacks.

Reimbursed Expenses - Significantly expanded details relating to expenses of the Adviser, its affiliates, employees, operating partners, senior advisers, strategic advisers and other long-term consultants that were reimbursed by private funds and/or their portfolio companies, including the methodology used to allocate such expenses across multiple private funds.

Principal Transactions - For each principal transaction, you must provide a description of the transaction, the participating parties and their roles, the date, the amount, how the valuation was determined, any terms outlining a payment plan or any expenses relating to the transaction other than the purchase price, and the reason for the transaction.

Custody Rule Exceptions - For any Private Funds for which an annual or surprise audit did not occur, an explanation as to why. 

Note: ACA has noticed that an increasing number of SEC registered private markets fund managers are failing to get audits of co-investment funds, friends-and-family funds, employee funds and liquidation funds primarily to save on audit fees for the benefit of investors in such funds. This request is a further indication that the SEC has started to intensify its scrutiny of such potential custody rule violations – and serves as a cautionary note for the foregoing fund managers.

Service Providers - Notable expansion in the scope of requests relating to service providers, which may now encompass details relating to service providers directly/indirectly retained by a private markets firm to provide services to fund portfolio companies/properties. Additionally, we have seen newer-type initial requests asking for details around the nature of a supervised person’s economic interests in a service provider and the terms on which the Adviser retains the services of a service provider for itself vis-à-vis the terms on which such service provider has been retained to provide services to a Fund or portfolio company/property.

Fund Auditor Opinions & Findings - If applicable, provide any letters from a fund auditor to the Adviser expressing independence or other ethics issues, disagreements with management of the Adviser, significant delays in obtaining documentation from the Adviser, financial statement misstatements, or other difficulties in conducting the audit.

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Download our Private Markets Quarterly Update

This is just one of the many insightful articles included in our Private Markets Quarterly Update 2021 Q3. Download the full newsletter to learn about: 

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  • Noteworthy Recent Trends in SEC Examinations and Enforcement Actions
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  • Practical Tips on How Private Fund Managers Can Enhance their Side Letter Management Processes Amidst Increase in Regulatory and Investor Scrutiny
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  • EU Cross Border Fund Distribution Directive and Regulation - Raises More Questions than it Answers?
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