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Capital market private equity funds should consider Cybersecurity, due diligence and conflicts of interest before the SEC appears for an exam.

Private Equity Advisers: Key Regulatory and Investor Issues to Consider

Private equity funds, which play a critical role in our capital markets, continue to see fierce competition in investor fund-raising.  At the end of first quarter of 2017, a record 1,098 private equity funds globally are seeking capital targeting an aggregate $635 billion of commitments.1   While investors generally consist of institutional investors, retail investors can also be impacted by private equity fund performance.  For example, pension funds often invest in private equity funds to generate higher rates of returns for their retirees.  As investor appetite for private equity funds grows, so will the increased scrutiny for SEC-registered private equity fund advisers.

Although the SEC is under new leadership, many of the recent enforcement actions will likely keep key regulatory issues in the forefront.  Indeed, many institutional investors expect fund managers to have clean regulatory records before they commit capital to funds, and will inquire about such issues during their fund due diligence.  Examples of inquiries often include verification of the compliance program beyond paper policies and procedures, and confirmation that key principals understand their regulatory and ethical obligations.  Therefore, private equity fund managers should continuously examine their compliance program under the Investment Advisers Act of 1940.

Perhaps the most important issue for regulators and investors relating to private equity fund managers is conflicts of interest--very common in the private equity industry.  Fund managers should ask 2 essential questions: 

  1. Where do conflicts exist with respect to our business and strategy?
  2. Have we adequately managed these conflicts and disclosed them to investors so they can make informed decisions when committing capital?

Usually, conflicts around fees and expenses get private equity fund managers into trouble, which was highlighted by recent SEC enforcement cases.  In August 2016, the Commission imposed a fine of $52.7 million on 4 private equity fund advisers affiliated with a major asset manager for fee disclosure and improper expense practices.  The fee disclosure failures included (a) acceleration of monitoring fees to investors; and (b) interest payments on a loan from the adviser’s affiliated general partner to the funds.    The improper expense practices included a then-senior partner of the firm charging personal expenses to the funds and their portfolio companies.  Other recent enforcement cases include a failure to disclose fee allocation practices, receipt of impermissible transaction fees, and an improper transfer of money from fund accounts to the advisers’ accounts.

Other key issues private equity fund managers should consider include, but are not limited to:

  1. The role(s) of limited partner advisory committees;
  2. Valuation policies;
  3. Cybersecurity practices; and
  4. Allocation of investments.

It’s always advisable for private equity fund managers to test the effectiveness of their compliance programs before the SEC appears for an exam in order to adequately and promptly identify and remediate issues. 

Enforcement cases costing millions of dollars can be avoided with proactive oversight, management and correction of deficiencies.


1 Preqin Quarterly Update:  Private Equity & Venture Capital Q1 2017.

Venkat Rao is a Director in the Compliance and Regulatory Services Practice. He works with hedge funds, private equity funds, commodity pool operators, registered investment advisors, broker-dealers, investment banks and insurance companies.

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