SEC inspections mean all hands on deck

Almost half of GPs have been subject to an SEC inspection in the four years since examinations began. As the US Securities and Exchange Commission sharpens its scrutiny of private funds. Only four percent, according to a poll of delegates at PEI’s Private Fund Compliance Forum, have been examined more than once.

And inspections are getting tougher as the regulator’s knowledge of private equity and that of its examiners’ deepens. “The SEC learns from SEC exams,” one delegate said.

Examinations aren’t just an empty threat – the regulator has backed them up with enforcement proceedings. In mid-2015, KKR was the first firm to be penalized for the pre-2011 misallocation of broken deal expenses in its private equity funds and fined $30 million. It was followed by Blackstone, which paid $39 million in October to settle charges related to disclosure failures.

Having a state-of-the-art compliance program and co-operating with the SEC are the best ways for fund advisors to prepare for an examination, CCOs said. All employees need to be briefed, even if the SEC does not interview everyone. One chief compliance officer who has been through the process commented: “it was definitely all hands on deck.”

Several CCOs told pfm that their firm conducts regular mock examinations as a means to cast a fresh pair of eyes over their existing compliance program, although these dry runs can be extremely time consuming and difficult to schedule.

One CCO even takes the time to research each examiner on LinkedIn before they arrive at the firm’s offices to understand their perspectives and background.

While not everyone may go that far, it’s clear that firms must prepare for the demands on its time and resources that an examination imposes, particularly those with multiple strategies that can expect to be examined on each one.

Typically the SEC gives little warning. The process usually starts with a phone call announcing the arrival of SEC examiners on a specific date in two to three weeks. This is accompanied by a lengthy survey of about 100 questions that need to be answered that day.

During an examination up to four examiners can situate themselves in a general partner’s office for up to a week. “The first day is really key in setting the tone,” said one delegate.

In future, the process could become even more rigorous. The SEC is widely expected to expand the scope of topics it examines, with some CCOs speculating that the regulator might start to ask additional questions about platform companies, a firm’s operating partner model and performance measurement. One delegate, whose firm has been through the inspection process, said that during its examination, the SEC suggested the firm used net IRR in addition to gross IRR.

No one is in any doubt that an SEC exam is a highly stressful exercise that requires the allocation of considerable resources. But overall, CCOs were of the opinion that many firms come out of the process enriched. “It was a learning experience,” said one.

The SEC would probably say the same.