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4/16/19 - How Private-Fund Advisers Can Better Prepare for SEC Exams

Private-fund advisers manage complex assets and frequently employ complex strategies and structures. Given, in part, the significant shift of pension assets to alternative asset classes,1 the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations formally established the private-funds unit in 2016. The PFU is a nationwide, designated exam unit that cultivates expertise on private-fund advisers by hiring industry experts, providing training on private funds, and examining private funds.

The PFU develops exam initiatives in response to industry themes or patterns of widespread conduct, uses data analytics to identify exam targets based on its initiatives, and conducts risk-based exams on a national scale. Though focused exclusively on private funds, the mission of the PFU is no different from OCIE’s: “[T]o protect investors, ensure market integrity, and support responsible capital formation through risk-focused strategies that improve compliance, prevent fraud, monitor risk, and inform policy.”2

The PFU develops tailored exam initiatives on an annual basis. In some instances, a PFU initiative is carried out in conjunction with one of OCIE’s national or regional program initiatives for investment adviser/investment company exams. Most PFU exams, however, are typically driven by a specific PFU initiative (i.e., one not tied to a general IA/IC initiative); a referral from a regional office’s exam program, based on resource needs; or the SEC’s program for tips, complaints, and referrals. That said, the SEC receives information on its registrant base from a variety of sources, and other factors can lead to an exam at any time.

It is impossible for the chief compliance officer of a private fund adviser to predict with 100% certainty the scope of an exam, the questions the PFU will ask, or the documents it will request. Although the PFU initiates exams after identifying firm-specific risk factors, the scope of an exam can evolve quickly if new information comes to light.

There are four ways that an adviser’s CCO can and should strategically prepare for a PFU exam, which are discussed below.

1. Challenge Your Awareness and Understanding

An underrated but critically important success factor for a PFU exam is the CCO’s understanding of the firm’s business. To assess risks, develop controls, and detect and prevent potential violations of securities laws, a CCO must be highly knowledgeable of the firm’s business areas, including new ventures, information sharing, trading, research, due diligence, marketing, vendor relationships, valuation, revenue generation, fee and expense allocation, investment allocation, cybersecurity, and so forth.

If a CCO is unable to answer an important question about the firm’s business activities and associated risks, the PFU exam team will naturally wonder whether the firm’s compliance policies and procedures are reasonably designed to prevent violations of the Investment Advisers Act of 1940. Exam teams expect CCOs to be involved in, and acutely aware of, day-to-day happenings at their firms. The exam team can determine very quickly during an initial meeting whether this is the case, and what it learns will undoubtedly inform the scope of the exam. For example, the exam team will not hesitate to incorporate a valuation review within the scope of the exam if it determines that the CCO is unable to readily describe the firm’s valuation policy or valuation processes for various asset classes.

To ensure they have the requisite awareness and understanding, CCOs should start by making sure that they can answer several basic questions about the business, including:

  • What is the firm’s investment strategy(s)?
  • Within which strategies are AUM concentrated, and which strategies are most and least profitable?
  • How many employees does the firm have in each function?
  • What is the makeup of the firm’s investor base?
  • Where are the investors geographically located?
  • Does the firm have co-investors or separately managed accounts? What about affiliates or registered affiliates?
  • What products does the firm trade?
  • What types of private investments has the firm made?

Depending on the size and complexity of the firm, documenting answers to the questions above could prove useful. Critical to any robust risk-assessment program is a summary of the firm’s business activities and risk factors, which should be refreshed, as necessary, after each assessment.

Robust reporting and governance can enhance awareness and understanding. For instance, effective reporting and escalation processes ensure that compliance teams receive complete and timely metrics and information about business and control processes. In addition, CCOs who serve on internal committees (e.g., investment or valuation committees) can stay abreast of key issues and developments. Similarly, incorporating ad-hoc walk-throughs and demonstrations into monitoring and approval processes will ensure the compliance team remains engaged.

Developing this level of knowledge is critical. A PFU exam team is far more likely to test adherence to a firm’s allocation policy and disclosures if the compliance department reveals during interviews that it is unclear how to apply and implement the policy or disclosures. Compliance teams should also focus on any area of the firm’s business that may be an outlier relative to its peer group. Through the information-gathering process and use of analytical tools, PFU exam teams will likely identify these areas as worth probing during exams.

2. Organize and Streamline Documentation

PFU exam teams expect compliance departments to produce documents promptly and explain any discrepancies or issues in a timely manner. Compliance teams can facilitate a smoother exam process by ensuring documents are organized and readily accessible. Required records should also be organized and electronically shareable — significant preparation or clean-up should not be required for requests of evidence of compliance reviews, valuation support, or vendor due diligence, to name a few examples. In anticipation of an exam, a compliance team should check with the adviser’s fund administrator to make sure it can respond to any requests in a timely fashion. The quicker the compliance team can produce documents during an exam, the faster and easier the exam will be.

3. Educate Key Stakeholders

Ensuring that key stakeholders understand compliance and regulatory issues relevant to their roles and responsibilities ahead of time is essential to not only prepare for PFU-exam interviews, but also to draft adequate responses to exam requests. Even the most compliance-conscious senior managers do not necessarily view their daily activities through a compliance lens, and therefore may have trouble articulating control processes and risk considerations during interviews.

Interviews are important elements of any exam. A PFU exam team will often request interviews with key stakeholders in each business area, who they expect to be readily available during the exam and transparent in their communications. In addition, an exam team will request, in writing, detailed explanations of specific transactions or processes, which key stakeholders may be responsible for providing.

The compliance team can prepare key stakeholders for an SEC PFU exam and related interviews by exploring particular topics with them and asking them specific questions. For instance, what are the specific risks to investors or market integrity associated with your business or role? If or when you identify compliance or regulatory concerns, which escalation processes are you responsible for? Such questions can be asked informally throughout the year and/or formally during preparation for an exam interview.

4. Practice Transparent Communication

Advisers should clearly convey their ability to meet expectations as early in the exam process as possible. In most cases, exam teams will be willing to accommodate reasonable delays in document production or scheduling conflicts if made aware of such delays or conflicts at the outset of the exam.

The onsite portion of the exam, or “field interviews,” is how a PFU exam team learns about an adviser’s business, oversight processes, and decision-making processes. Should advisers communicate openly and transparently, exam teams are more likely to reciprocate by sharing potential exam findings or explaining areas they intend to further analyze. In addition, during field interviews, interviewees should not answer questions that they do not know the answer to, that they are not authorized to answer, or that would require speculation. Rather, interviewees should ask to consult the right person to respond to a specific question, or ask to refer to records so they can provide a clear and accurate response. Taking these extra steps during the interview will result in less confusion on issues or processes that an exam team would otherwise have to revisit.

Regular check-ins with an exam team after an onsite visit will result in a faster exam. Advisers should request recurring meetings or reach out to the lead examiner or exam manager on a regular basis to receive status updates, gauge responsiveness, clarify issues, and determine if there are any findings or potential findings the exam team is ready to share. An exam team will, in most cases, appreciate an adviser’s willingness to exchange information.

Transparent communication will lead to informed discussions about potential exam findings. Moreover, when compliance is able to provide an exam team with a complete and accurate understanding of how it oversees the business, it can reduce any unexplained or unclear issues that might otherwise result in a deficiency letter.

Exam Outcome Scenarios

PFU exams can be time-intensive, burdensome, and costly — both from a resource and a reputational perspective. The result of a PFU exam is most often a deficiency letter, which is used to communicate potential securities-law violations to an adviser. In these letters, the PFU will request written responses within 30 calendar days describing actions taken (or to be taken) by the adviser to address or remediate the findings. If the adviser disagrees with the findings, it should provide a detailed explanation of its rationale, with supporting examples, in a response letter. Deficiency letters and response letters are extremely important, because, ultimately, they are used by investors to evaluate advisers’ compliance programs. Often, current or prospective investors will ask to review deficiency letters, along with an adviser’s responses to them, as part of their due-diligence processes.

In some instances, PFU exam teams may refer their findings to the SEC’s division of enforcement for further investigation or action. Over the past five years, 6% to 12% of examinations resulted in enforcement referrals. Typically, an exam team will not inform an adviser whether it plans to make an enforcement referral. However, an adviser may be able to decipher whether an enforcement referral is likely, either from the nature of the exam findings detailed in the deficiency letter or through discussions with the exam team.

Actively preparing for a PFU exam significantly reduces the odds that an adviser will receive a deficiency letter or be referred to the division of enforcement. Firms that adhere to the aforementioned principles will ensure that PFU exams run more smoothly, and they will demonstrate their commitment to a best-in-class compliance program that meets regulatory and investor expectations alike.

How We Can Help

Promontory is uniquely qualified to help private-fund managers prepare for PFU exams. Our asset-management group is comprised of a number of industry experts and former regulators, including a former SEC exam manager.

Contact Us

Please contact one of our professionals to discuss how we can help you prepare for PFU exams or meet current and future regulatory requirements.

Jane Jarcho
Special Adviser
+1 202 384 1200

Conway Dodge
Managing Director
+1 202 370 0461

Sarah Curran
+1 212 542 6763


  1. Victoria Ivashina and Josh Lerner, “Looking for Alternatives: Pension Investments around the World, 2008 to 2017,” Federal Reserve Bank of Boston (April 24, 2008).
  2. About the Office of Compliance Inspections and Examinations,” Securities and Exchange Commission.
  3. Fiscal Year 2018 Annual Performance Report,” SEC (March 19, 2019).