The Securities and Exchange Commission has indicated that it will take a risk-based approach” to the examination of newly registered advisers to private equity funds. But what should advisers expect if SEC examiners come calling?
Carlo V. di Florio, Director, Office of Compliance Inspections and Examinations, responded to this question in a speech last month. He stressed that examiners will be assessing the effectiveness of the firm’s internal controls for identifying and remedying conflicts of interest, including its process of creating and adapting compliance policies and procedures.
He further noted that some of the risk areas regarding private equity that might be considered during an examination include:
- What is the Fund strategy? Does the Fund control portfolio companies or hold only minority positions? Is the strategy to invest with other firms or alone? Does strategy make general sense? Are investments in easily understandable companies?
- How clear are investor disclosures around ancillary fees (particularly those charged to portfolio companies), management fee offsets and allocation of expenses? How robust are the processes to ensure compliance with those disclosures?
- Does the firm have a complicated set of diverse products? If so, how are inter-product conflicts managed? These conflicts can arise, for instance, from two products investing in different parts of a deal’s capital structure or products competing for deal allocation.
- How sophisticated and reliable are the processes used by the Fund? Is the valuation process robust, fair and transparent? Are there strong processes for compliance with the fund’s agreements and formation documents? Are compliance and other key risk management and back office functions sufficiently staffed? What is the quality of investor communications? What is the quality of processes to ensure conflict resolution in disputes with or among investors?
- What is the overall attitude of management towards the examination process, its compliance obligations, and towards risk management generally, compared to its peers?
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