Ensure SEC Compliance with a Foolproof Expense Allocation Process

“When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50% of the time.” – Andrew J. Bowden, Former Director, Office of Compliance Inspections and Examinations (Source).

Following this statement made by Andrew Bowden in 2014, the U.S. Securities and Exchange Commission (SEC) has regularly fined private fund managers for improper expense allocation. Most recently, the SEC proposed new rules to make fees and expense allocation more transparent, delivering on its responsibility to safeguard investors and the integrity of financial markets. This proposal is in line with the increasing number of requests from investors to standardize expense allocation policies, making it crucial for private fund managers to have a foolproof expense allocation process in place to ensure SEC compliance.

In a recent Indus Valley Partners webinar, Director Ashish Kumar Jain began his talk by providing attendees with a recap of the SEC’s OCIE examination priorities for 2022 following the completion of 3,040 total examinations in 2021. From these examinations, the SEC issued more than 2,100 deficiency letters and 190 enforcement referrals, leading firms to return more than $45 million to investors due to misallocations or miscommunication in their expense and fee management policies, according to Jain.

During the webinar, it was revealed that 83% of poll respondents have a mostly manual process and only 27% do secondary checks to ensure their expense allocation policies have been complied with. Expense Poll :

For firms that perform the expense allocation process manually using spreadsheets, the potential for misallocation and miscommunication is far more likely. However, there are a number of industry best practices that managers can implement to improve their expense allocation process while avoiding common challenges. According to Jain, these best practices include:

• Automated Data Capture – By using technology tools to automate invoice capture, managers can reduce manual intervention and replace with supervision.
• Workflow-Based Approach – With a clearly defined workflow that each type of invoice follows, managers can establish stronger controls.
• Remove Allocation Method Discretion – Setting up a process that determines allocation rules itself can reduce errors caused by employee discretion or inconsistency.
• Automated Data Sourcing – Making data such as allocation basis available systematically can help capture delta if the allocation basis changes.
• Execution of Expense Policy – Enforcing the expense policy automatically will ensure it is not only followed on paper but in practice by raising alerts and warnings.

For more of Jain’s insights about building a foolproof expense allocation process, view the on-demand webinar recording. You can also learn about IVP’s Expense Allocation Solution here or contact us at  sales@ivp.in.

Click here for more stories.