Regulators, limited partners and prospective investors are paying closer attention to how firms handle key compliance areas:
As private equity attracts broader investor participation, the SEC has intensified its scrutiny across the industry. That attention is not limited to large advisers. Smaller firms are also facing exams at a higher rate than in previous years. Managers are facing increased attention as regulatory findings and fines are being levied across various aspects of firm operations, with regulators placing greater focus on firm practices, not just outcomes.
As the industry continues to evolve, regulators, limited partners (LPs) and prospective investors expect you to clearly document and follow processes around valuation, governance and marketing, among other core areas.
Given this increased regulatory attention, PE leaders need to understand each of the top compliance challenges and take a proactive approach to mitigating the associated risk. Here are some of the most widely recognized compliance challenges to manage in the months ahead.
Valuation is arguably the most pressing compliance concern for today’s PE fund managers. As exits have slowed, continuation vehicles have become more prevalent and investors have placed greater focus on unrealized gains. As a result, it is no longer enough to arrive at a reasonable valuation. Regulators expect a strong valuation policy and internal control framework surrounding the process.
Regulators are increasingly focused on documentation, consistency and independence. Your firm must maintain written policies and procedures, documentation supporting valuation determinations and a clear link between the final valuation and the process used to arrive at it. These governing documents cannot simply be drafted and filed away. They must be regularly referenced and consistently followed.
As managers grow and add funds or strategies, allocating shared expenses fairly across funds, co-investments and management entities becomes increasingly complex. Without precise and transparent controls and processes that help ensure expenses are allocated equitably, mistakes can quickly erode LP trust and raise enforcement risk.
In recent years, it has become more common to see advisers required to reimburse entities for improperly allocated expenses, in addition to paying regulatory fines. Fund managers should ensure that no entity receives preferential treatment and that all expenses charged are permitted under the governing documents of the applicable fund. Expense allocation should be evaluated during every accounting period, not just when a fund is launched.
A Limited Partnership Agreement (LPA) governs how a fund operates as a whole, but legacy side letters that provide reduced fee arrangements, reduced carry allocations or other concessions can create obligations that differ from the terms of the LPA.
Any divergence between the LPA and actual fee arrangements, allocations or other practices will generate questions from regulators and auditors. This issue is often more prevalent in older-vintage funds, where handshake or napkin agreements were followed but not fully documented.
At a time when expense allocations and management compensation remain key areas of regulatory focus, it is critical to ensure that any departures from the LPA are properly documented and stored.
The SEC has stepped up its monitoring efforts for PE firms, including more random exams than it has historically conducted — especially at smaller organizations. Whistleblower complaints and issues at portfolio companies can also trigger unexpected regulatory attention.
When that happens, preparation matters. That’s why it’s essential to have clear documentation on hand that shows both the process and the rationale behind your decisions. Without it, isolated issues can expand into broader regulatory reviews that increase costs, create unnecessary disruption and potentially wreak reputational havoc.
AI is an emerging area of risk for private equity firms as it becomes more widely used in valuations and due diligence for portfolio companies.
Data sharing is a crucial concern. If you input confidential or proprietary data into AI tools, it may be accessible to third parties. That creates legal, financial and reputational risk. Data governance is another key concern. How are you sourcing data, and how are you preventing biases from creeping into outputs you generate?
There’s also concern around marketing AI-focused funds. If you’re promoting funds with concentrated investment in AI, expect the SEC to intensify its focus, much like it did with ESG-directed investments a few years ago. Regulators will want to know how you’re selecting investments in this asset class, validating fund performance data and marketing the funds.
Investors are diving deeply into performance metrics before committing to PE funds, given the expanded capital markets and sheer number of opportunities in the space today. They expect clear, accurate information about your track record, fund performance and expenses. Who’s running the fund? What were their past investments, and how did they perform? What was the expense ratio over the life of previous funds?
The SEC is focusing intently on every detail you’re putting out in slide decks, marketing letters and other marketing materials, right down to your disclaimers. Your data must be accurate, verifiable and presented consistently. Take a fine-tooth comb to what you’re sharing before you provide the information to investors and implement strong review processes to ensure that only approved, up-to-date materials are used.
Investors and regulators alike hold high expectations for what you are doing within your portfolio companies, especially in majority-owned positions. Compliance failures at the portfolio-company level can cause problems that extend to your firm, including issues related to labor concerns, data privacy, operational controls or potential conflicts of interest.
These issues can expose LPs to legal risk and reputational damage, potentially delaying exits, complicating transactions and impacting valuations. Having a clear understanding of your portfolio companies and demonstrating active oversight is necessary to avoid these consequences, but don’t stop with technical compliance. Consider how potential concerns may be perceived, because reputational risk is significant in private equity.
Avoiding enforcement triggers isn’t easy when many of the highest-risk compliance issues are driven by process gaps, not bad intentions. Implementing best practices now can help you avoid disproportionate disruptions later. Learn how our experienced private equity advisors can help you tackle regulatory challenges, strengthen compliance processes and reduce risk across your entire organization.
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