Davis Polk Investment Management practice head Leor Landa was quoted in Private Equity Law Report discussing the SEC Divisions of Examinations’ 2024 examination priorities.

Historically, the SEC engaged with the industry before major rulemakings went into effect, so there was a sense of the regulator’s approach before compliance dates, Leor noted. “That does not seem to be occurring to the same extent lately and the SEC seems more inclined to provide substantive feedback and guidance indirectly through examinations, which can be a challenge for the industry.”

One of the priorities emphasized is verifying that fund managers are meeting contractual requirements regarding LP advisory committees (LPACs). There seems to be some concerning movement toward the SEC intervening in contractual arrangements between GPs (General Partners) and LPs (Limited Partners), notwithstanding that many LPs are well resourced, heavily represented and have significant bargaining power, Leor said. Investor organizations are not calling for change on that front, and regulatory intervention may skew the markets in potentially inefficient ways.

In the last few years, there has been a focus on side-by-side management and how managers ensure they allocate investment opportunities and resources fairly, Leor continued. There are real conflicts of interest, but they are obvious, and managers tend to navigate them thoughtfully, often by implementing formulaic processes that can be applied impartially or by defining the investment strategies in a way that avoids overlap, he noted.

The SEC also noted it would review portfolio management risks, which may include private funds experiencing poor performance. The focus on poor performance is interesting, Leor said. The SEC seems to be mindful of the impact the 2008 global financial crisis had, especially as to leverage runs or liquidity mismatching. However, the market has shifted its approach toward managing liquidity in times of stress, and any future recession should not result in such traumatic consequences, he added.

Another priority will be verifying that due diligence practices are consistent with a firm’s policies. The focus on the due diligence of portfolio companies is part of a trend for the SEC to second guess business judgments, Leor said. In a number of exams, and sometimes in deficiency letters, the SEC has criticized investment risk or financial decisions. “Provided they meet their regulatory obligations, it is the purview of managers to make decisions about appropriate risks, not the SEC,” he reasoned.

“If a manager is ignoring its disclosure and not doing what it told LPs it would do, that is fair game for the SEC,” Leor continued. “But let’s not stray into an area where managers feel like they’re not allowed to operate with a normal level of discretion or take into account variables.”

Leor also noted that there has been a lot of SEC enforcement activity around fees and expenses, explaining that recent SEC exams have been looking at:

  • when and how managers step-down the management fee and base;
  • what the base of the management fee is in a PE fund;
  • how underlying assets are valued as a portfolio evolves; and
  • what is considered disposed, written down or written off.

“The issue regularly arises in exams now so it would not be surprising if more enforcement actions follow,” he said.

An additional focus has been on policies and procedures for reporting on Form PF. Focusing on Form PF reporting seems to reflect the SEC’s generally more aggressive approach toward exams and enforcement, Leor said. The SEC monitors changes to Form PF and considers whether that should trigger an exam, so it is important to the regulator that updates are reported promptly, he explained.

One notable omission in the list is artificial intelligence (AI). An AI exam sweep of private fund managers is underway and the SEC has spent considerable time in that area, so it was surprising that it was only mentioned in a list of emerging financial technologies, Leor said.

“2024 SEC Examination Priorities: New Approaches to Old Areas of Concern,” Private Equity Law Report (December 14, 2023) (subscription required)

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