Regulatory Compliance Watch | SEC Examines PFs’ Third-party Valuations

Apr 2023

Originally posted by Regulatory Compliance Watch on March 31, 2023.

The SEC is asking private fund advisers to explain how they monitor the boundaries between their firms and third-party valuation experts as well as communications between fund and valuation company staff. It is not clear, however, if the SEC’s requests are from a greater concern about influence on valuations or for a discreet investigation.

Private fund valuations have been a key focus for regulators since the Great Recession. SEC Chairman Gary Gensler and aides suspect that private fund fees are too high, pointing to valuation models as the cause. Regulators have also accused funds of unloading fiduciary duties off on outsourced firms and have proposed new rules that would require advisors to vet and re-vet third-party providers. Examiners have shared that they want advisors to understand that some jobs can be outsourced, but responsibility cannot.

The increasing specificity of the SEC’s requests indicates that regulators are more closely examining private funds. In the SEC’s FY 2024 budget request, the Division of Examinations requested 20 new examiners.

Due to market uncertainty, there is an increased risk of regulator attention on noisy investors, particularly for firms that focus on high-net worth or retail investors.

Richard Olson, Managing Director in Lincoln’s Valuations & Opinions Group, commented, “There are times when the markets become disorderly and you almost have to ignore the noise and focus on portfolio company fundamental performance, which is a key driver of private company valuations. For certain investors, that’ll be fine. They’ll be able to ignore the noise, they don’t need the liquidity. Within the group of high net worth and retail investors, though, sometimes folks will have different liquidity and time horizons than managers.”

Regulators are examining all material closely and have become increasingly apt in locating errors. Firms must pay attention to all details to ensure compliance.

The SEC’s questioning of the collaboration between private fund advisors and valuation agents could be a problem for managers. In order to gather data and learn about holdings, managers must work with third-party valuation agents. Regulators may find it difficult to determine the difference between normal collaboration and wrongful influence, and any difference drawn can impact the valuations industry and the entirety of the private markets.

Additional insights can be found in the original article.