Auditor Independence: What Registered Investment Advisors Need to Know

Understanding Auditor Independence

Auditor independence has been a contentious issue for several years. In March 2024, PwC faced a $2.75 million fine related to independence violations, underscoring the heightened scrutiny from regulators.

This issue is further reinforced by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), which mandates that private fund managers with $150 million or more in aggregate assets under management must register with the U.S. Securities and Exchange Commission (SEC) and adhere to its auditor independence rules.

These registered investment advisors (RIAs) are often considered to have custody of investor funds because the general partner of a private equity fund limited partnership or the manager of a limited liability company (LLC) typically has the authority to take possession of, or transfer assets without the consent of the limited partners or members.

SEC auditor independence extends to investment companies when the audit client is a registered private equity fund OR has an advisor who is registered with the SEC. That means that private funds managed or advised by an SEC registered investment advisor must find a Public Company Accounting Oversight Board (PCAOB) registered and inspected firm to be compliant with the Custody Rule, as described below.

Why PCAOB Registration & Inspection Matters

Under the custody rule, PCAOB registration and inspection status is required for:

1. The surprise examination of the assets in custody (Rule 206 exams).
2. The audit of the managed pooled investment vehicles that is distributed to investors.
3. The internal control report that is obtained by the advisor or received from the qualified custodian.

Ensure that your service provider is both registered and inspected to remain compliant with the Custody Rule. When evaluating new firms, verify that their inspection status is not dependent on a limited client base. If they lose key clients, they risk losing their inspection status and falling out of compliance with the Custody Rule. This would mean the investment firm would need to find a new service provider.

Typical SEC Independence Violations

• Auditor drafts the financial statements on behalf of the fund
• Auditor provides valuation or tax provision templates
• Auditor performs non attest services (such as the preparation of the tax provision) for portfolio companies it controls
• Auditor performs non-attest services for other private equity funds under common control and portfolio companies under their control, if they meet the SEC affiliate definition

Auditor independence is a cornerstone of compliance for registered investment advisors and private equity funds. Ensuring adherence to SEC and PCAOB standards safeguards against penalties and maintains trust with stakeholders.

Whether you need guidance on compliance, Custody Rule requirements, or PCAOB registered and inspected independent auditors, contact our team to learn how we can support you in navigating these complex regulations effectively.