Off-diary compliance reviews

The thought of inspectors from the US Securities and Exchange Commission (SEC) gathering in a firm’s front lobby makes compliance officers (unsurprisingly) uneasy. 

Turns out, so too do the rehearsal inspections some fund managers are having consultants carry out to find any gaps in compliance and make recommendations on best practices.  

What’s got GPs worried, it seems, is SEC inspectors getting their hands on the notes or final report from such a compliance review/mock audit. Despite the fact that the SEC is generally thought to look favorably upon firms that hire advisers to enhance their compliance programs, there are a number of compliance “gray zones” that can result in disagreements between the firm and an outside consultant as to how to proceed, says one New York-based chief compliance officer. 

“We may interpret a rule or requirement differently than our consultant. It’s not always black and white,” he said. 

If no resolution is reached, the compliance officer is left holding a report that flags a compliance gap or need for improvement that the firm doesn’t necessarily agree with, nor intend to address the way a consultant recommends. Having to present such disagreements to an SEC inspector can be uncomfortable, and GPs worry that the SEC could end up siding with the consultant’s viewpoint in such instances.

The solution isn’t to stop having outside consultants stress test GPs’ compliance programs, the compliance officer noted. Instead, some firms are requesting all this work be done orally. No written documents. No after-action reports. No chance for inspectors to request records of a consultant’s disagreement with his firm’s interpretation of a rule or requirement. Multiple compliance consultants confirmed to PE Manager that some firms have been requesting oral mock audits for these purposes.

But that’s not the only solution for firms feeling nervous about mock inspections, says Barry Schwartz of ACA Compliance, a consultancy group that conducts such inspections. “If a private equity firm reaches out to us through their outside law firm, they can choose to conduct the mock exam under attorney – client privilege.” In other words, the consultant’s report would not be subject to SEC inspection under those circumstances.

Finally, sources say, should a firm elect to go ahead and have the consultant’s audit recorded in writing as is traditionally done, the compliance officer should formally address the review. Having a written response to a consultant’s findings on file is a way to demonstrate the firm’s compliance team has digested the third party advice, even if they don’t intend to follow it. That should give them one less thing to be nervous about, even if it’s not off-diary.