SEC examiners are focusing on private funds’ compliance with the custody rule, and outside auditors may not be helping, a compliance expert cautions.
“We’re seeing overall a lot of focus on private equity and venture capital funds,” ACA Group director Vivek Pingili tells Private Funds CFO. “We’re seeing a lot of interesting activity on the custody rule front.”
Two consistent problems are coming out of the exams, Pingili says. The first is that, under pressure from investors over their fees, fund advisers have cut back on outside audits for their co-investment, friends-and-family, employee and liquidation funds.
“A lot of people aren’t auditing those funds,” Pingili explains. “Now we’re seeing regulators get tough, especially about private fund audits. Work with your auditors. The money flowing through all these funds – make sure you can account for all of it.”
The second problem is that, even when advisers hire outside auditors, they’re sometimes “getting bad advice,” Pingili says.
Auditors focus on generally accepted accounting principles (GAAP). The difficulty is that the custody Advisers Act rule, 206(4)-2, is more stringent than GAAP.
“If the audit doesn’t pick up the flow of every dollar to every fund, there’s a gap there,” Pingili notes. “Don’t just take the accountants’ word for it.”
Pingili urges private fund advisers to “have a game plan. If you’re not auditing a portfolio company, have a good explanation for why you’re not.”
He adds that he’s seeing not only more direct questions about the custody rule, but also longer look-backs in private fund exams – sometimes up to four years. So far, regulators have been flexible with advisers.
“But at some point, they may want to make an example of someone,” Pingili cautions.