SEC examinations (conducted by the Division of Examinations, formerly OCIE) can happen to both registered investment advisers and Exempt Reporting Advisers. While ERAs face a lower probability of examination, they are not exempt from the process. Knowing what the SEC looks for and how exams work helps you avoid the most common deficiency findings and respond effectively if you receive an examination notice.
How Examinations Work
SEC examinations typically begin with a document request list sent before the on-site (or remote) examination. This initial request is broad and covers the foundational records the examination staff needs to understand your firm. Expect requests for:
- Organizational documents (LPA, operating agreements, GP formation documents)
- Compliance policies and procedures manual
- Fund offering documents (PPM, subscription agreements, side letters)
- Written communications with investors
- Financial records (ledgers, capital accounts, fee calculations, bank statements)
- Personal trading records and code of ethics acknowledgments
During the examination, the staff conducts interviews with key personnel, reviews additional documents based on what they find in the initial production, and tests specific areas of compliance. Examinations can be conducted on-site at your office or remotely through document submissions and video interviews. The length varies from a few days to several weeks depending on scope.
Common Focus Areas
The SEC publishes annual examination priorities, but certain areas receive attention in nearly every private fund examination:
- Fee calculations and expense allocation. The SEC examines whether management fees are calculated correctly per the LPA, whether expenses charged to the fund are permissible under the fund documents, and whether fee offsets are applied as required. Fee-related deficiencies are among the most common findings.
- Valuation practices. How you value portfolio investments, what methodology you use, whether you follow a consistent valuation policy, and whether valuations are reasonable. This is particularly scrutinized for illiquid investments where fair value is subjective.
- Conflicts of interest. Whether conflicts are properly disclosed, how you handle situations where the manager's interests diverge from LP interests (co-investments, affiliated transactions, expense allocations), and whether your ADV accurately describes your conflicts.
- Custody rule compliance. Whether you are meeting the audit exception requirements, whether audited financials are distributed on time, and whether your custody arrangements are properly disclosed on Form ADV.
- Marketing materials. Whether performance presentations comply with the marketing rule, whether claims in pitch decks and DDQs are accurate and substantiated, and whether disclosures are adequate.
Examination Outcomes
After the examination concludes, the SEC staff issues one of several outcomes:
- No action. The examination found no significant issues. You will not receive a deficiency letter.
- Deficiency letter. The most common outcome. The letter identifies specific areas where your firm is not in compliance with applicable rules. You must submit a written response describing the corrective actions you have taken or plan to take.
- Enforcement referral. In serious cases, the examination staff refers the matter to the SEC's Division of Enforcement for potential action. This is reserved for significant violations, repeated deficiencies, or fraud.
Many examinations result in no findings or minor deficiencies. A deficiency letter is not an enforcement action. It is an opportunity to correct issues before they become more serious. The SEC expects a thorough, timely response that addresses each deficiency.
Preparation
The best preparation for an SEC examination is ongoing compliance. If your records are organized, your policies are followed, your fees are calculated correctly, and your disclosures are accurate, an examination should be a manageable process rather than a crisis. Specific preparation steps include:
- Maintain clean records. Organized, accessible records reduce the time and stress of responding to document requests.
- Follow your own policies. The SEC often identifies deficiencies where firms have compliance policies but do not follow them. A policy that exists on paper but is not implemented is worse than not having a policy at all.
- Document decisions. Investment committee decisions, valuation conclusions, fee calculations, and expense allocations should all be documented contemporaneously. Reconstructing the rationale for decisions months or years later is difficult and unconvincing.
- Conduct periodic internal reviews. Annual compliance reviews (required for RIAs, recommended for ERAs) help identify and correct issues before an examination finds them.
- Engage counsel if you receive notice. When you receive an examination notice, engage experienced securities counsel to help manage the process, prepare responses, and identify potential issues.
- Respond thoroughly and on time. Incomplete or late responses to document requests create a poor impression and can extend the examination.
- Do not clean up after notice. If you receive an examination notice, do not alter, destroy, or create records to make your compliance look better. This can transform a minor deficiency into an obstruction issue.
This article is for informational purposes only and does not constitute legal advice. Consult qualified professionals for guidance specific to your situation.