Open the books

Demands from investors will have more firms than ever looking into more rigorous third-party oversight, such as the SAS 70 audit.

Firms in the US received some good news earlier this week with the introduction of a bill that would exempt private equity and venture funds from registering with the Securities and Exchange Commission. But while firms are hoping to escape heavy government regulation, their LPs may demand even more rigorous self-regulation.
The bill introduced by Senate Banking Committee Chairman Christopher Dodd maintains previous exemptions he had proposed for private equity and venture capital, on the grounds they do not pose the same systemic risk as hedge funds. The bill must be reconciled with legislation in the House which has no such exemption, although concerns about stretching the SEC’s resources too thin may favour Dodd’s more limited regulatory approach.
To what degree firms have to comply with new regulations is almost beside the point, as in either case they are going to be increasingly dealing with investors who want more reassurance in this post-Madoff world. Those GPs that can point to transparency, strong controls and procedures and third-party validation will set themselves apart in the eyes of LPs.
One way to demonstrate this is is to undertake the thorough and expensive SAS 70 audit, which was recently completed by Adveq International. The fund of funds manager completed both Type I and Type II of the examination, the latter of which covered its investment management, fund administration and information technology practices. 
While SAS 70 has been around for decades, it has rarely been undertaken by private equity managers. That may be changing: in the past year, funds of funds Capital Dynamics and HarbourVest went through the third-party review due to increasing requests from investors. 
The downside is the audit process can be time-consuming and expensive. Both Type I and II can cost up to $100,000 each. But for firms that want to be seen as best in class by LPs, they may find it is time and money well spent.