NY Forum: Attendees outline exam expectations and best practice tips

An SEC examination can be intimidating, which makes preparation vital for firms when examiners come knocking.

The SEC doesn’t publish its exam priorities until the end of the first quarter, but speakers at the 20th annual Private Funds CFO New York Forum said they expect valuations, conflicts of interest and compliance with the new Marketing Rule to be top areas of focus for private fund examiners in 2023.

Knowing potential focus areas will help firms prepare, but there are other steps they can take to help them during their next SEC exam.

“One thing that I would tell firms [when they] prepare for an SEC exam is to look at everything,” advised one CFO/COO.

“You should look at the SEC’s exam priorities and try to match that up with what you’re doing,” they continued. “Look at risk alerts and enforcement actions because they are a great data set for what is on examiners’ minds right now.”

The CFO/COO added that these various SEC data sets will help firms identify any weak areas they may have, or areas in which they need to improve compliance. Firms can also get examples of recent exam letters and document request lists to know what they need to have prepared before an exam.

Mock exams: One GC/CCO said it can also be helpful to reach out to compliance consultants to conduct mock exams or to do a risk assessment of the firm to identify potential heightened areas of risk.

Leverage your network: Finally, the CFO and managing director of a PE shop said firms should not be afraid to leverage their network by reaching out to peers and asking about their exam experiences to be better prepared and, maybe, to get ahead.

Do what you say you’re doing

Attendees at the forum said that documenting your valuation process is critically important to fulfilling examiners’ expectations. “The SEC is going to come in and ask for your valuation policy, they’re going to go through it and make sure that you are following what you say you’re doing,” the CFO/COO said.

Consistent application of the valuation is also important. When examiners come in, they’re less likely to ask firms about the valuation methodology used than they are to ask about changes to the methodology or instances where the firm deviated from the stated practice.
Firms should also use their LP advisory committees as a sounding board on valuations to try to uncover unclear practices or areas where more transparency or better explanations are needed. “We reach out to our LPAC on things we’re thinking about doing to get their advice and feedback, and they try to identify complexities and challenges,” the CFO/COO said.

The Marketing Rule: With the SEC’s new Marketing Rule in effect as of November 2022, examiners will be conducting sweep exams of firms’ compliance, trying to ferret out practices they don’t like and asking managers what changes they’ve made to their firms’ policies and procedures to affect compliance.

“I think it’s really going to be a bit of a ‘wait and see’ exercise when it comes to the new marketing rule and what the SEC finds objectionable,” noted the GC/CCO. “I think it will take a while to work through all of the questions and changes, so I think this will be a major area of focus for the SEC in exams for a while.”

Conflicts of interest: Finally, the commission will again look at how firms manage conflicts of interest. Forum attendees said the best practice for private equity firms is to review their fund documents to see what conflicts must be disclosed and how they may be mitigated.

Examiners are expected to really focus on firm-level conflicts, such as expense allocation, investment allocation and related parties. “I would say best practice is to have a good body of evidence to show that you really tried to find and mitigate conflicts of interest, and that you clearly disclose to your investors what conflicts you might have and how you deal with them,” the CFO/COO said.