In-person exams resume

The Securities and Exchange Commission is set to resume in-person examinations, and some are worried, according to affiliate title Regulatory Compliance Watch.

In the Commission’s recently released exam priorities, regulators look ahead. “We also expect,” they say, “to increase our on-site interactions with regulated entities while continuing to leverage remote examinations where it makes sense to do so.”

“It’s not a good thing,” says David Tang, partner at Dorsey & Whitney. “They had gone to full remote since the pandemic. I was under the impression they were going to stay that way because remote exams were so much efficient.”

Costs (and value)

Private fund advisers might be forgiven if they think they’ve seen a great deal of the SEC over the past few years. Tang says in-person exams ratchet up the anxiety.

“They go to get a coffee and there are two analysts in the coffee room. That’s a problem,” he says. “They might say, ‘Hey, where are the compliance files? Oh, I see it has no key.’”

Exams are already costly for fund advisers. It’s not just what it costs funds to hire lawyers or spend staff time on document requests or interviews—though that’s expensive, too. Last year, the average private equity adviser spent $12 million on outside counsel, Private Funds CFO reports.

The exams themselves cost advisers money. The SEC claims its staff found enough errors in its routine exams last year that advisers had to return nearly $50 million to investors.

Reasonable doubt, reasonable retainers

For private fund advisers, the problem isn’t just that compliance is expensive and only getting more costly. It’s also that compliance tends to get more expensive just as markets get wobbly. Venture capital fundraising hit a nine-year low last year. Private equity fundraising fell off by $100 billion, affiliate title Private Equity International reports. As cash gets tighter, investors get noisier, and regulators get antsier.

The other problem is that compliance—expensive as it is—is also a market advantage, says Richard Olson, managing director at Chicago-based consulting firm Lincoln International. Whatever regulators do on the private fund reform front, investors have already made up their mind about a few things, Olson says. One of them is transparency. They want a lot more of it, Olson says.

“There’s a tiering that’s appeared in 2022 fundraising,” he says.  “The data shows that larger asset managers have dominated fundraising last year, while the smaller asset managers have not had the same level of success. How are the big guys winning the fundraising game? One of the primary reasons they are winning is because they’re able to deliver what limited partners want, and that is greater transparency about the valuations of their underlying investments. Investors want to know their investments have been marked fairly and independently, and not just on the basis of the manager’s views.”

That means firms that can afford to spend on compliance have a two-tier advantage: First, in being able to fend off or at least absorb enforcement actions, and second in being able to market their compliance program over their upstart rivals. Consider: Last year, Blackstone spent $53.4 million in legal fees for a single firm – Kirkland & Ellis, the firm says in its most recent Form 10-K filing. According to the SEC’s own data, that’s about 1.6% of net assets value of the average private equity fund.