SEC auditor independence considerations for private equity funds

What to watch for when working with a registered investment adviser or pursuing an initial public offering

Aug 02, 2021
Audit Financial services Private equity SEC matters

When a private equity fund has a registered investment adviser

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires most advisers of private funds to register with the SEC as investment advisers and to comply with the Investment Advisers Act of 1940. The U.S. Securities and Exchange Commission (SEC) requires registered advisers to maintain certain safeguards to maintain all securities at a qualified custodian. One of the safeguards required under the Act is that the registered investment adviser is subject to surprise examinations. The surprise examinations are required to be conducted by a firm that is registered with the Public Company Accounting Oversight Board and must be conducted under the independence requirements of the SEC.

It is important that the registered investment adviser, private equity fund management and the management of all portfolio companies be aware of certain SEC independence considerations, which are outlined in this whitepaper.

When a private equity fund portfolio company may have an initial public offering

If a private equity fund portfolio company is considering an initial public offering (IPO) as a possible exit strategy, U.S. Security and Exchange Commission (SEC) auditor independence rules should be considered well in advance of the IPO. Proper application of SEC auditor independence rules is required for all audited periods presented in financial statements filed with the initial registration statement.

The number of years of financial statements that must be audited will depend on the specific registration form used. If the portfolio company has been in existence for more than two years, the financial statements presented generally would include balance sheets as of the end of the two most recently completed fiscal years and statements of income, shareholders' equity, and cash flows for each of the past three fiscal years. Certain IPO registration statement rules for smaller reporting companies and emerging growth companies (as defined), if available to the portfolio company, allow the presentation of statements of income, shareholders' equity, and cash flows for only the last two fiscal years.

These requirements create a look-back period of two or three years where the auditor needs to reassess its independence under SEC rules with respect to the portfolio and its affiliates. The SEC has stated that auditors should anticipate IPOs by private equity fund portfolio companies and is becoming less inclined to allow independence violations during the look-back period.

This whitepaper outlines the SEC independence rules that should be considered by a private equity fund portfolio company in advance of doing an IPO.