SEC Issues a Significant No-Action Letter for Registered Investment Advisers Managing Private Funds

On October 12, 2010, the United States Securities and Exchange Commission ("SEC") issued a significant no-action letter ("SEC Letter") for registered investment advisers managing pooled vehicles ("Private Fund"). The SEC Letter provides time sensitive guidance concerning SEC Rule 206(4)-2 (the "Custody Rule") and the annual audit requirements. Among other conditions, SEC Rule 206(4)-2(b) (4) (ii) requires that the annual audit of the Private Fund be conducted by "an independent public accountant that is registered with, and subject to regular inspection as of the commencement of the professional engagement period, and as of each calendar year-end, by the Public Company Accounting Oversight Board ("PCAOB"), in accordance with its rules.

Only auditors to public companies are currently subject to regular inspection by the PCAOB. However, Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), signed into law on July 21, 2010, provides the PCAOB with authority to develop rules to establish a regular inspection program for auditors.1

Many auditing firms may not be subject to regular inspections by the PCAOB, as a result, many advisers have pre-existing engagements with independent auditors that do not adhere to the regular inspection requirements and, technically will not be compliant with the Custody Rule. The SEC Letter acknowledged that this aspect of the Custody Rule will be disruptive to certain advisers that would be required to replace their auditors until their auditors become subject to the PCAOB's regular inspection requirements. The SEC also correctly acknowledged that changing a Private Fund's auditor would likely result in additional expenses to investors of the Private Fund.

As such, the SEC concluded that it would not recommend enforcement action if an adviser engages an auditor that is not subject to the regular inspection requirements; provided that, the adviser meets the following three (3) conditions:

1. The auditor must have been engaged to audit the financial statements of the Private Fund for the most recently completed fiscal year;

2. The auditor was registered with the PCAOB and engaged to audit the financial statements of a broker or a dealer July 21, 2010 and is registered with the PCAOB and engaged to audit the financial statements of a broker or a dealer as of the issuance of audited financial statements used to satisfy the annual audit provision; and

3. The adviser provides written notification to each investor prior to the distribution of the financial statements that the Private Fund's auditor is not subject to regular inspection by the PCAOB.

As the third condition is critical, if you need assistance in developing the written notification to your investors, please contact Daniel G. Viola at 212.573.8038 or

1 See Dodd-Frank Act Section 982, these rules will also apply to registered broker-dealers.

Cheryl Spratt