Exam Findings for Private Funds

Exam Findings for Private Funds

06 July 2020

Main Contributor: Elizabeth Cope, CPA, CSCP, CIPM, CEO & Lead Consultant


The SEC issued a risk alert on June 23rd that provides a summary of the results the staff discovered when conducting exams of investment advisors that manage private funds. If you are an advisor to private funds (all types including private equity) or plan to be, we highly recommend you read through this article to determine whether you need to make adjustments to your disclosures and/or your policies and procedures.

The findings are broken up into three main categories:

  1. Conflicts of Interest
  2. Fees and Expenses
  3. Policies and Procedures for Material Non-Public Information or “MNPI”

We have summarized the risk alert below.  For full details of the SEC’s findings, please read the Risk Alert.

Conflicts of Interest

As an investment advisor to private funds you must either eliminate or make full and fair disclosures of all conflicts of interest so the underlying investors can make sound decisions about their investments. The disclosures must also be sufficient for the investor to understand the material facts and circumstances that apply. The SEC provided a list of conflicts they felt were not appropriately disclosed. Below is a list we suggest reading through to see if any might apply in your situation. This is not an exhaustive list, so as you scroll through, think about other instances unique to your firm that might warrant disclosures.

  • Allocation of investments among various funds
    • Allocating investments to only select funds
    • Allocating investments at different prices or in different amounts
    • Allocating investments in a manner inconsistent with the process disclosed
  • Multiple investors investing in same portfolio company
    • Investors investing at different capital structures (i.e. one owning debit and another owning equity)
  • Financial relationships between investors and the investment advisor
    • Seed investors
    • Investor that provided credit or other financing
  • Preferential liquidity rights
    • Side letters with preferential liquidity terms
    • Side-by-side vehicles investing alongside fund with preferential liquidity terms
  • Private fund interest in recommended investments
    • Owners or employees have a financial interest/ownership in the investments being recommend to the funds
  • Co-investments
    • Disclosure of opportunities between co-investments and other managed funds
    • Arrangements/agreements with select investors for co-investment opportunities
  • Service Providers
    • Use of service providers controlled or affiliated by owners, employees, or underlying investors
    • Financial incentives for using selected service providers
  • Fund restructurings
    • Investment advisor purchasing fund interests from an investor at a discount
    • Lack of transparency on the options available during a fund restricting
  • Cross-transactions
    • Purchase or sell between funds and investors at disadvantaged pricing

Fees and Expenses

If you have been in this business for a while, it should come as no surprise that one of the topics is fees and expenses. The SEC has always expressed their concerns with how fees and expenses are allocated to the funds. Here is a summary of the deficiencies identified:

  • Allocation of fees and expenses
    • Allocating fees and expenses inconsistently with policies and disclosures
    • Charging expenses not permitted by the fund’s operating documents
    • Not complying with contractual limits on expenses, causing overpayment
    • Not following travel and entertainment expense policies, causing overpayment
  • Operating Partners
    • Compensation of operating partners (that are not employees) not being fully disclosed
  • Valuation
    • Not valuing assets in accordance with policies and disclosures – leading to overpayment of management fees and carried interest
  • Monitoring fees, board fees, deal fees, and fee offsets
    • Failure to calculate and allocate management fee offsets correctly
    • Failure to track receipt of portfolio company fees
    • Failure to disclose long-term monitoring fee arrangements

Policies and Procedures for MNPI

Investment advisors must maintain a Code of Ethics that sets forth the standards of employees’ personal trading and policies to prevent the misuse of MNPI by the investment advisor and its personnel. The following is a summary of the deficiencies identified by the staff as it relates to MNPI:

  • Lack of policies to prevent misuse of MNPI through:
    • interactions with insiders of publicly traded companies, expert networks, value added investors to assess if in possession of MNPI
    • employees that obtained access to MNPI (that didn’t need access) through the office space or system access
  • Code of Ethics
    • Not enforcing and properly managing restricted list for MNPI
    • Lack of gift and entertainment policy and enforcement of policy
    • Failure to submit personal trading reports

SCS Suggests

We suggest your firm adopt the following procedures, where applicable, to help you identify and manage your firm’s adherence to compliance.

  1. At least annually, or more often as new deals and business relationships form, conduct an analysis and log identified risks and conflicts. If a disclosure was deemed unnecessary, substantiate your understanding of the facts and circumstances to support this conclusion.
  2. Facilitate a questionnaire for your staff to ask questions regarding potential conflicts and access to MNPI and have them affirm they have fully disclosed all information.
  3. Review emails of your staff on a periodic basis. We can speak from experience that firms have found instances of undisclosed and unreported relationships.
  4. Have compliance be a part of deal team discussions or at least encourage open communication and dialogue with compliance to ensure reporting of conflicts and MNPI.
  5. Facilitate an annual review that reviews and tests the fees and expenses being charged to the funds (and underlying investors).
  6. Facilitate an annual review that confirms the timely reporting of personal trade reports and review of trading activity for adherence to firm policy.
  7. Train your staff. Education is probably the best tool you must ensure compliance surrounding these issues.
  8. Review your policies and disclosures at least annually to ensure they meet all requirements, best practices, and are consistently applied.


Risk alerts are a great opportunity to review the underlying practices of your firm and set expectations among your personnel. An annual review that incorporates a review of risks and conflicts and regularly reviews and tests all areas of compliance will help ensure your firm’s ability to identify, manage, and correct deficiencies.

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