Service providers under fire

Auditors, lawyers and other service providers are experiencing their own regulatory pressure, which is having a trickle-down effect on private fund managers. 

If you’ve noticed the cost of third party services going up, this isn't just to do with supply and demand. The US Securities and Exchange Commission (SEC) has been making loud, scary noises that auditors and also lawyers who don’t do enough to catch clients' bad behavior can be held liable, which has led to these specialist service providers taking a more compliance-minded approach themselves.

The latest example of the trend came last month, when Connecticut-based audit and accounting firm Halpern & Associates was accused of “improper professional conduct” by straying too far from generally accepted accounting principles when reviewing the books of a broker-dealer. Among other things, the commission said the audit didn’t exhibit enough “professional skepticism” in considering the reliability of records provided by the client, and questioned the competence and experience of the individual leading the audit (who apparently had a scant six months of audit work experience under his belt).

For valuation providers especially, the regulatory pressure has been intense – which could lead to a rare kind of ripple effect on fund managers. Over the past few years, SEC officials have become increasingly vocal about the need for greater credentialization within the valuation profession. In 2013, then SEC chief accountant Paul Beswick called the valuation profession “highly fragmented” and wanted ways to improve the reliability and consistency of valuations. Over the last year, a number of valuation professional organizations including the International Valuation Standards Council and global valuation leaders from several large accounting firms took his warning to heart, and began meeting with SEC officials to explore solutions. A similar meeting is planned later this month, with representatives from the different valuation bodies planning to release an action plan for public consultation later this year. Expect the SEC to go after any auditor or valuation provider that fails to honor the defined best practices springing from the initiative. 

For private fund managers, the takeaway from all this is twofold: One, understand that service providers are raising prices in order to ensure sufficiently experienced team members and due diligence are being devoted to each client; not just for the sake of professionalism, but also to avoid SEC action. And two, realize that settling for the most affordable option when choosing a service provider creates potential for indirect regulatory risk: if they fall in the SEC’s crosshairs – even for something not related to your firm – stakeholders may find you guilty by association.

A few years out now from Dodd-Frank, it is clear what type of impact SEC-registration has had on the fund management industry. But we may begin to more clearly witness the indirect impact of greater regulation over service providers on GPs in the time ahead. This isn't surprising given the relentless rise of regulation we've been seeing. Neither it is something fund managers should take lightly.