Case Study: The Cost of Non-Compliance and How to Avoid It

Private funds—hedge funds, private equity funds, venture capital, and real estate funds—have long enjoyed more regulatory flexibility than their public counterparts. However, recent years have seen a sharp increase in SEC compliance oversight, driven by investor protection priorities and enhanced transparency demands.

In 2025, SEC enforcement actions against private fund advisors are more aggressive, targeting compliance failures in valuation practices, fee disclosures, conflicts of interest, and custody rule violations. For fund managers and GPs, non-compliance isn’t just a legal risk—it’s a reputational and financial threat.

Why SEC Oversight of Private Funds is Intensifying

The SEC, under Chair Gary Gensler, has prioritized greater accountability and transparency across all investment vehicles. Notably:

• New Rule Updates (2023-2024): The Private Fund Adviser Rules introduced stringent requirements around quarterly statements, audits, and side letter disclosures.

• Increased Exams and Audits: The Division of Examinations continues to heighten scrutiny on smaller and mid-sized fund advisers, particularly those with gaps in compliance infrastructure.

• Data-Driven Enforcement: The SEC now leverages advanced analytics and whistleblower reports to detect anomalies and suspicious behavior more efficiently.

Key SEC Compliance Areas for Private Funds in 2025

To remain in compliance, fund managers should actively monitor the following risk zones:

1. Fee and Expense Allocations

Improper allocation of fees (e.g., charging portfolio company expenses to the fund) remains a top violation.

2. Valuation Practices

Inconsistent or manipulated valuations of illiquid assets can lead to inflated NAVs, misleading performance, and legal exposure.

3. Conflicts of Interest

Undisclosed preferential treatment, cross-transactions, or family office involvement can trigger enforcement.

4. Custody Rule Violations

Failure to adhere to the Custody Rule (Rule 206(4)-2), especially regarding surprise exams and use of qualified custodians.

5. Marketing and Performance Claims

Misrepresenting IRR, cherry-picking data, or lacking substantiation for back-tested models may violate the Marketing Rule (Rule 206(4)-1).

Case Study: The High Price of Non-Compliance

Firm: AlphaGrowth Capital (Fictitious Composite Based on Real Cases)
Fund Type: Mid-sized Private Equity Fund (~$1.2B AUM)
Issue: Undisclosed fee arrangements, inaccurate valuation methodologies, and marketing misrepresentations.

🚨 What Went Wrong:

• Undisclosed Fees: AlphaGrowth charged portfolio monitoring fees to portfolio companies without offsetting management fees, as contractually obligated.

• Valuation Failures: Internal models were used to inflate valuations, diverging from independent pricing services and without adequate disclosures.

• Marketing Violations: The fund's pitch decks included performance metrics that lacked proper substantiation and exaggerated IRR calculations.

💸 The Fallout:

• SEC Fine: $6.5 million in civil penalties

• Disgorgement: $3.8 million in ill-gotten fees

• Reputational Damage: Two major institutional investors withdrew commitments from AlphaGrowth's next fund.

• Operational Cost: $1M+ spent on forensic audits, legal counsel, and implementing a new compliance infrastructure.

📉 Long-Term Impact:

• Deferred fundraising timeline by 18+ months

• Key partners departed citing compliance mismanagement

• SEC required independent compliance consultant oversight for 24 months

Best Practices for Private Fund Compliance in 2025

If you're a fund manager, CFO, or CCO, here’s how to stay ahead of regulatory risk:

✅ Establish a Robust Compliance Program

Ensure your compliance manual, code of ethics, and risk controls are reviewed annually and tailored to your fund's operations.

✅ Conduct Regular Internal Audits

Don’t wait for the SEC to find problems. Internal reviews can preemptively catch issues with valuation, expenses, or disclosures.

✅ Document Everything

From valuation models to investor communications, maintain a clear paper trail that demonstrates good faith, diligence, and accuracy.

✅ Engage Third-Party Consultants

Compliance specialists and external auditors can help validate your controls and support readiness for an SEC examination.

✅ Prepare for the SEC’s New Reporting Regime

Stay current with the Form PF amendments and any new quarterly or side letter disclosure obligations.

Conclusion: Compliance is Not Optional

In today's environment, SEC compliance isn’t just a legal checkbox—it’s a strategic pillar for fund sustainability and growth. The risks of non-compliance with private fund rules are significant, both in cost and credibility. Proactive compliance strategies can protect your firm, attract investors, and ensure long-term viability.

Want Help Assessing Your Fund’s SEC Readiness?

Our team offers compliance risk reviews, mock SEC exams, and policy development support tailored for private fund advisers.
👉 Contact me:  cory@fincompliance.io to learn more or schedule a free consultation.