Exam Priorities Spotlight: Focus on Private Equity and Real Estate Advisers


Erika Chua and Kristina Staples

Publish Date


Compliance Alert


  • Compliance

How can private equity (PE) and real estate (RE) advisers best prepare for regulatory exams in 2021? While we provided an overview of the 2021 Examination Priorities (Priorities) of the U.S. Securities and Exchange Commission’s (SEC) Division of Examinations (Division), PE and RE advisers should consider whether they are prepared to respond to inquiries in the following areas.

Fees and expenses

The SEC staff have focused on the fees and expenses of PE and RE firms for many years now, and this year is no exception. We continue to see heightened regulatory interest in services provided by affiliates and we expect the Division to consider whether sufficient disclosures have been provided to investors if the funds or portfolio assets are paying fees to or otherwise reimbursing affiliates for certain services. This scrutiny may also include a review of the arrangements for individuals that are typically referred to as “operating partners” – experts (often former employees of advisers or portfolio companies) engaged by the adviser to provide services to portfolio companies and who are typically compensated by the portfolio companies and/or funds. In addition, we are seeing significant attention from the SEC staff in situations where a portion of the compensation of employees of the adviser or an affiliate is paid by the funds or portfolio assets.

Advisers that charge portfolio companies, properties, or funds for employee time, overhead expenses, salary, bonus, or other benefits or for services provided by affiliated entities or operating partners should confirm that they have made clear disclosures about this practice.

Environmental, social, and governance (ESG) strategies and risks

Starting in 2020, the SEC staff signaled their interest in examining firms that claim they consider ESG factors as part of the investment process – and provided some insight into these exams in the recent Risk Alert on ESG investing. ESG makes another appearance in the 2021 Priorities, with some additional context.

The Priorities mention qualified opportunity zone funds (OZ funds) as an ESG strategy that Division staff will explore. OZ funds are focused on real estate in certain areas that are designated as “qualified opportunity zones,” and OZ investments can provide significant tax benefits for investors. Advisers to OZ funds should be prepared for regulatory scrutiny of claims made in marketing materials and offering documents about ESG considerations or the social impact of investments in OZ funds. OZ fund investors typically also consider the tax benefits of these investments, so advisers should ensure they provide sufficient disclosures regarding any potential tax benefits and related risks.

To the extent a PE or RE adviser claims to consider ESG factors as part of the investment due diligence or monitoring process, the adviser should be able to show documentation supporting their ESG efforts. For example, some advisers who invest in physical real estate represent to prospective investors that they consider climate risks as part of their investment due diligence process. Compliance officers should confirm that any ESG-related claims are reflected in the firm’s investment due diligence memos or records of ongoing monitoring and that the firm can demonstrate it is following any ESG-related policies.

Pandemic-related risks to investments

The Division is concerned about the impacts the coronavirus pandemic may have on the types of investments held by RE and PE advisers. For example, the Priorities mention the following:

  • Concerns about non-performing loans or increased default risk in CLOs or mortgage-backed securities
  • Portfolio valuations and the impact of any pandemic-related market stress on those valuations
  • Distressed asset sales

Advisers should be prepared for significant scrutiny of their valuation processes and should be sure they are able to support changes that were (or were not) made in asset valuations throughout the pandemic. While most RE and PE advisers do not charge fees based on valuations, performance numbers typically incorporate valuations and therefore asset-level valuations can impact an adviser’s ability to raise a new vehicle. 

In addition, advisers that invest in real estate debt should consider whether existing disclosures about the risks of those investments need to be updated. Recent articles in the press on the potential use of inflated income in underwriting commercial loans held in commercial mortgage-backed securities (CMBS) may cause examiners to more carefully scrutinize the underwriting and valuation of debt investments.

Finally, to the extent advisers are forced to sell distressed assets or make the decision to “give back the keys,” they should maintain records of all attempts to obtain the highest price possible or the justification for “giving back the keys” and be sensitive to the appearance or existence of potential conflicts of interest when disposing of such investments.

Fund-level concerns

The Priorities include a focus on liquidity-related conflicts. For PE and RE advisers, this can occur when funds have reached the end of their life, but the fund is unable or unwilling to sell assets in the current environment. Advisers in this situation should carefully review the options available in the fund offering documents and maintain records supporting the actions taken, such as extending the fund’s life with consent of the advisory board or providing any type of in-kind distribution. If a fund is continuing beyond its stated life, the adviser should consider how it can minimize any potential conflicts of interest, including whether the adviser should still receive fees or charge the fund for certain expenses.

How to prepare

The Division’s 2021 Priorities help advisers understand some of the topics that might be of interest to examiners. We recommend that advisers consider disclosures made to investors and documentation maintained to demonstrate compliance with the firm’s policies and procedures considering the above priorities. 

How we help

Our experienced consultants can conduct focused reviews or mock SEC exams to assess your firm’s level of preparation for these areas of interest as well as other regulatory requirements and expectations. Contact your ACA consultant or contact us here to learn more.

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