Understanding Fund Audits and Compliance Obligations
Fund audits and regulatory compliance are essential pillars of responsible fund management. For fund managers, limited partners, and compliance officers, understanding audit procedures and legal obligations is critical for maintaining transparency, investor trust, and adherence to governing regulations. This article outlines the key legal and procedural requirements surrounding fund audits and compliance obligations.
The Role of Fund Audits
Fund audits provide an independent evaluation of a fund's financial condition, operations, and adherence to accounting standards. Audits serve multiple purposes:
Verifying the accuracy of financial statements
Confirming the proper valuation of assets and liabilities
Ensuring compliance with Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS)
Providing assurance to limited partners and regulators
Legal and Regulatory Frameworks
1. Investment Advisers Act of 1940
Registered investment advisers (RIAs) are subject to the Investment Advisers Act, which imposes specific recordkeeping, disclosure, and custody requirements. Rule 206(4)-2, known as the "Custody Rule," is particularly relevant to fund audits.
Key requirements include:
Annual surprise examination or independent audit of funds by a PCAOB-registered accounting firm
Delivery of audited financial statements to investors within 120 days of fiscal year-end
Maintenance of books and records available for SEC inspection
2. Private Fund Adviser Rules and SEC Oversight
The SEC has increased its scrutiny of private funds, particularly related to:
Valuation methodologies
Expense allocation
Preferential treatment of certain investors
Proper audit procedures help demonstrate compliance and mitigate enforcement risk.
Common Audit Focus Areas
1. Valuation of Assets
Auditors examine whether valuations are fair, reasonable, and in line with the fund’s stated policies. This includes:
Reviewing pricing methodologies for illiquid or hard-to-value assets
Assessing internal valuation committees and processes
Verifying documentation for assumptions used
2. Fee and Expense Allocation
Audits scrutinize whether management fees, performance fees (carry), and fund expenses are:
Calculated accurately
Disclosed properly to investors
Allocated consistently with governing documents
3. Side Letters and Preferential Terms
Auditors and regulators often request to review side letters to confirm that:
Terms are disclosed and applied consistently
No material conflicts of interest exist
Impact on other investors is clearly addressed
4. Internal Controls and Governance
Auditors assess the effectiveness of:
Compliance programs
Risk management frameworks
Cybersecurity and business continuity planning
Compliance Best Practices for Fund Managers
1. Maintain Comprehensive Documentation
Keep accurate records of financial transactions, valuations, agreements, and investor communications. Documentation is essential for audit support and regulatory inquiries.
2. Engage Qualified Auditors
Select a Public Company Accounting Oversight Board (PCAOB)-registered firm with experience in private fund audits. Ensure alignment with the fund's complexity and asset classes.
3. Implement Internal Compliance Controls
Build a compliance program that includes:
Regular internal audits
Periodic risk assessments
Whistleblower policies and training
4. Enhance LP Communications
Regularly update limited partners on audit timelines, findings, and corrective actions taken. Transparent communication strengthens investor trust.
5. Monitor Regulatory Developments
Stay abreast of changes to SEC rules, IRS reporting obligations, and international standards affecting fund audits and reporting. Engage legal counsel to assess impacts and update compliance procedures.
Potential Consequences of Non-Compliance
Failure to comply with audit and regulatory obligations can lead to:
SEC enforcement actions and monetary penalties
Reputational harm and investor withdrawals
Legal disputes with limited partners
Barriers to future fundraising or registration
Fund audits and compliance obligations are not simply formalities—they are foundational to legal and operational integrity. By prioritizing robust audit processes and adhering to regulatory expectations, fund managers can protect investor interests and position their firms for sustainable success.
If your fund requires legal guidance on audit readiness, compliance policies, or SEC reporting, contact our firm at 786.461.1617. Our attorneys provide tailored legal support to help you meet your fiduciary, regulatory, and governance responsibilities with confidence.