Posted by Jake Biondo and Colin McLaughlin
One of the most important aspects of managing and advising investment funds is to protect those who invest in your fund. This includes providing them with timely audited financial statements to assist them in making critical investment decisions and reinforce confidence in their fund investments.
To comply with the “audit provision” of the SEC Custody Rule, financial statements of private investment funds managed by Registered Investment Advisers (RIAs) need to be audited and distributed to investors within 120 days of the respective fund’s year-end. As such, it is critical for funds to meet this deadline. For an RIA, missing this deadline can result in civil penalties, increased scrutiny from regulators, as well as a potential decline in market reputation.
Yet, many RIAs, and particularly those responsible for complex digital asset funds, miss this deadline each year. In our experience, the key steps below can help you and your audit team be O.N.T.I.M.E. for this important deadline:
Fund management must take full ownership of the fund accounting and the preparation of financial statements. Your audit team can only work through the audit efficiently if your team stays on top of all requests, proactively brings new items to the audit team’s attention, and reviews the financial statements for accuracy and completeness in detail. Generally, we have experienced success when fund administrators prepare the financial statements and fund management then performs a detail review afterward.
Often, managers are not considering the impact of U.S. GAAP on their investment decisions — and the SEC custody rule requires your financial statements to conform with U.S. GAAP or accounting standards that are substantially similar. If an investment, or a selected accounting treatment, cannot meet U.S. GAAP requirements of fair value reporting, you should reconsider and consult with your counterparties/investee advisers before moving forward.
Implementing a structured timeline for deliverables and management communication is key to success. Communicate any new activities of the fund to your audit team and fund administrator early. Also communicate changes to any relevant counterparties — such as illiquid confirmation respondents, loan agents and custodians — who will need to be responsive during the pre-defined audit timeline.
We cannot stress this enough; we’ve seen the impact, both positively and negatively. The goal should be to provide deliverables before the deadline, leaving time for any unforeseen circumstances.
Management must take the time to research and build appropriate valuation models for all illiquid or hard-to-value investments. A one-size-fits all approach can cause audit delays down the road. Further, both fund management and your administrator will want to track complex activities. We often find errors in tracking balances or valuation over investments held within DeFi protocols when no review control exists.
There are key areas that occur during the execution phase of the audit that can help increase the likelihood of meeting the deadline. Interim testing is almost a necessity for key audit areas to help ensure compliance with the deadline, so moving up testing as much as possible during this period, especially for complex funds, is important. For the greatest efficiencies, your auditors should consider automated processes to assist in testing high-risk areas.
It might be obvious, but it really does matter. Not only should your team have years of experience working within the digital asset industry, but preferably should be well-versed on your fund’s strategy and investment activities as well.
Remaining compliant is critical as regulations continue to develop, the industry continues to institutionalize, and RIAs seek to expand potential offerings or build trust with limited partners surrounding compliance initiatives.
Though the SEC private fund adviser rule was overturned earlier in 2024, the expectation is that SEC examiners will still reference many of the provisions of the rule during RIA examinations. Additionally, the SEC’s “safeguarding rule” is currently awaiting finalization. Regardless, management should come into compliance on existing deadlines to be prepared for any future changes. It is the responsibility of RIAs to meet these changing demands head on.
Contact Jake Biondo, Colin McLaughlin or a member of your service team to discuss this topic further.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.