Of all the formulae that investors use to measure private funds, distributions to paid-in capital (DPI) stands out in many investors’ minds as one of the most straightforward. Put simply, DPI measures cash returned to investors as a percentage of what they invested in the fund. Investors concerned about the reality behind marketing hype, their cashflow or simply having liquidity to invest in a successor fund often value DPI as a way to discern a manager’s ability to actually return money to investors.

In reality, however, DPI is not nearly so simple to use. When considered in isolation from other data, DPI is flawed at measuring how skillfully a GP is managing investors’ money and overall fund performance – especially given variables such as fund maturity and investment strategy. At certain points in a fund’s life, expecting any DPI at all would make little sense.

This first article in a two-part series explains how DPI is calculated, how it contrasts with other performance metrics, its limitations and its growing popularity among investors. The second article will examine ways that DPI calculations can be distorted – both intentionally and unintentionally – to juice a fund’s performance numbers relative to reality.

For more on how DPI can be distorted, see “LP Concerns and Common Misconceptions About the Rise of ‘Synthetic’ Distributions (Part One of Two)” (Jul. 11, 2024).

Calculating DPI

Basic Formula

In a highly diverse PE market where lockups, illiquid investments and other factors can make valuations difficult – and where the subjectivity managers wield when valuing assets is an ongoing source of controversy – some investors demand a standard performance metric that appears to be devoid of any subjectivity, acknowledged K&L Gates partner Lance C. Dial. “DPI does not rely on a manager’s valuations. It is a pure, simple, hard and fast calculation showing how much cash comes back to you. It’s an objectively knowable thing,” he summarized.

Specifically, DPI is a ratio expressing the amount of distributions to LPs relative to the amount of capital paid into a private fund by LPs, summarized ACA Group partner Chase Frei. “DPI measures, as a ratio, the amount that has been distributed back to investors compared with the amount those investors originally contributed into the fund.”

The calculations used to determine a fund’s DPI are fairly simple, Frei explained. On an annualized basis, take the total amount distributed back to investors and divide it by the amount that they originally paid in to the fund. For example, if investors contribute $2 million into a fund and then the manager eventually distributes $1 million from the fund back to those investors, the DPI would be 0.5.

Key Variables to Consider

DPI can be a valuable performance metric if investors are broadly aware of what it does and does not measure. “It offers insight into the characteristics of the fund, but you have to consider it in view of the fund as a whole,” Dial summarized. “I’m not so concerned about DPI levels in and of themselves – it depends on the profile of the funds being evaluated,” concurred Simon Faure, managing director at IH International Advisors, an asset manager with €5.2 billion in assets under management.

Maturity and Strategy

Two important considerations when putting DPI in context are the maturity of a fund and the types of investments that it makes, Dial observed. “You would not, for example, expect a newly launched fund to have a high DPI, because you would not expect it to have lots of distributions,” he explained. “We have different expectations around DPI for an early-stage or seed-stage venture capital fund than for, say, a middle-market buyout fund,” added Neil Randall, managing director and head of PE at the Teacher Retirement System of Texas (TRS), a public pension overseeing $200 billion in assets.

See “Planting a Seed or Securing an Anchor: Finding Success As an Emerging Manager” (Nov. 14, 2024).

Conversely, it may be a red flag when a more mature fund has a low DPI, and does not specifically invest in infrastructure or distressed assets understood to take a decade or more to become profitable. “DPI offers a clear proof point around a manager’s investment strategy – can the manager source deals, create value and exit? It’s obviously one of the key aspects, so we definitely look at it,” Randall stated.

DPI can also provide insights into how a manager is managing a fund’s capital, which may not always align with certain LPs’ capital expectations. “If a fund has been around for a while and still has a low DPI, that may signal either that the fund doesn’t have the returns to finance distributions, or it is recycling its distributions to invest in new things and not paying out capital,” Dial said. “That may or may not be the type of fund you want to invest in.”

Investment Horizons

It is also worth noting that investment horizons that might make perfect sense in other contexts can mean little when evaluating a fund’s DPI, Faure observed. “If you’re investing in PE funds, you may care more about seven-to-ten-year periods than three-to-five-year periods, and you want to find out who can sustain performance over the long term,” he told the Private Equity Law Report.

Along those lines, abrupt exits can affect returns – and deliberately juice DPI figures on a short-term basis – without providing useful lasting indices, Faure continued. “For instance, assume a mid-cap fund has a portfolio of eight to ten companies. It could be in the bottom 50th percentile range for DPI on March 31st,” he posited. “And then, on May 1st, it could be in the top decile after one exit which happens to offer a ‘7X’ return – i.e., seven times the initial investment – and suddenly it looks like a supernova.”

Fund Size

The “7X return” scenario posited above also highlights the importance that a fund’s size and the number of investments in its portfolio can have on its DPI. “The smaller funds get, the more the devil’s in the details as to what DPI is telling you about performance and potential liquidity in general,” Faure elaborated. One successful transaction – or the absence thereof – can materially swing a smaller fund’s DPI in either direction, which investors must suss out when evaluating a fund’s performance.

On the other hand, DPI may more accurately represent the performance of a larger fund, Faure continued. “Given the tendency of larger funds to have larger portfolios, DPI is generally symptomatic of how much capital they’ve got tied up in deals. If their DPI is very low, maybe they’re not able to sell those assets which can, of course, raise further questions,” he explained. “Is that because your ambition for what you can receive for those assets is too optimistic and you’re not facing the reality of what the market would pay?”

“If they’re kidding themselves – and us, the investors – about the ultimate outcome of their strategy, that would obviously cause us to rethink whether we would want to stay invested with that large fund,” Faure emphasized.

Applying DPI

Cashflow Experience

Informed investors use DPI to assess a highly specific issue – i.e., investors’ cashflow experience with a given fund, Dial stated. “Let’s say the fund is not returning anything back, and your DPI over the measurement period is zero. You know that the fund is not paying investment capital back,” he posited. “Conversely, if a fund has a DPI of 1.5, that means it has actually returned 50 percent more than the investor paid-in capital, so people have made a lot of money.”

Although those DPI calculations may be objectively valid, any attempt to measure a fund’s performance without any further information would be vulnerable to some obvious blind spots, Dial asserted. “Let’s say you put a million dollars into a fund, and then it pays you back a million dollars which results in a DPI of one,” he posited. “That could mean either that all of my capital has been returned to me, and the fund has no more investments in it,” he said. “Or it could mean that the fund has doubled in size and distributed a million dollars of investments back to me.”

Mosaic of Performance Metrics

It is all too easy for investors to fall into the trap of treating DPI as a catch-all model for assessing a fund’s performance. Instead, to gain a picture of what capital still remains at play in a fund, it is advisable to unite DPI calculations with other metrics.

Aspects of DPI

Although there is a generally accepted formula for DPI, it is crucial to be aware of the differing metrics that come into play depending on whether one wants to measure gross DPI or net DPI, according to Seyfarth Shaw partner Steven A. Richman. Gross DPI uses the formula of total distributions divided by total capital contributions, he said. “For net DPI, however, you would back out fees and expenses to try to get a sense of the fee drag and expense drag on a fund.”

In addition, it is especially important is to consider DPI together with a fund’s total value to paid-in capital (TVPI), which is calculated by adding total distributions to residual value, and dividing the total by paid-in capital, Frei stated. “We think of DPI as being a component of the broader TVPI, because the part missing from the DPI is what remains in the fund, or the [residual-to-paid-in capital (RVPI)],” he explained. “We can derive the TVPI by adding the DPI to the RVPI, which is the amount that remains, to get the total value.”

Hence, many investors find DPI especially useful as a complement to TVPI, Frei argued. “For an investor, a high TVPI is great, but it is less than ideal if the value that is being calculated in that multiple is all unrealized investments,” he clarified.

Other Performance Metrics

Although DPI, TVPI, internal rate of return (IRR), multiple on invested capital and other individual metrics have their uses, none by itself is absolutely reliable for gaining a holistic view of a fund’s performance, according to Frei. Rather, they are complementary.

To illustrate the point, Richman posited a hypothetical fund with three $100,000 investments in three different assets. Three years into the fund’s life, the first of those investments realizes for $150,000, the second is still held at $100,000 and the third is written down to zero. “If you were looking at it from one point of view, you might say that’s a poor performing fund because it has a low IRR,” he pointed out. “Conversely, its 0.5 DPI after three years into the fund, with no additional context, looks pretty good because you would still expect the other investments to yield additional DPI. You’ve already returned half of your investor capital from one of the investments.”

Accordingly, it is important when looking at private funds, especially illiquid private funds, to not rely on any single performance metric, Frei said. “IRR is widely cited, but it is especially useful alongside other things such as TVPI and DPI. When you look at multiple types of investment returns, you can get a better picture of what’s actually going on with a fund by considering those metrics together.” That point was echoed by Richman, who noted that “most investors will look at all three factors – DPI, TVPI and IRR – to get an overall view of a fund’s performance.”

See our two-part series: “Fundamental Flaws of IRR and How Sponsors Can Avoid Distorted Calculations” (Nov. 12, 2019); and “Practical Steps Investors Can Follow to Diligence Flawed IRR Calculations” (Nov. 19, 2019).

Rising Popularity of DPI

Undoubtedly, DPI has seen a marked rise in recent years as the performance metric du jour among managers and investors. “Certainly, you’re seeing DPI applied more over the last ten years, and more PE and private credit investors are finding it useful,” Dial said. “Ten years ago, if a manager put DPI into its marketing materials, half the people who saw it would not know what it signified,” he continued. “Now the term has become common enough in the investing universe that investors know what it is.”

One trend that illustrates the growing popularity of DPI is its more ubiquitous presence in marketing presentations offered to institutional investors, Faure recounted. “DPI has become extremely popular to talk about, as indicated by the presentations I started to receive in the first quarter of 2024,” he recalled. “The first two slides typically show a fund’s level of liquidity generation, benchmarked against the fund’s peer group. And then, where people used to talk about net IRR and TVPI, suddenly all everyone cares about is DPI.”

The rise in DPI’s popularity is, in part, an outgrowth of the coronavirus pandemic, in Richman’s view. “If you look back ten to fifteen years ago, some funds were coming back to market on a fairly defined, periodic basis – roughly every three years,” he said. “Everything accelerated during the coronavirus pandemic, however. Managers started coming back for re‑ups and successor funds much more quickly,” he continued. “And so, if an investor was going to commit to a fund and then a successor fund, it became more important for them to know they would have the requisite liquidity,” he explained. “Hence, fund managers started using DPI to show how fast they were returning capital to their investors.”

In Faure’s view, that emphasis on returns is, indeed, a sure sign of the cash-strapped status of many investors in recent years. Investors weathered the global coronavirus pandemic and emerged from that difficult time with a renewed zeal for returns, along with straightforward metrics to capture their cash flow experience with a given fund. “They went into panic mode over their ability to fund commitments at the same pace that they had been funding them, and then started asking GPs, ‘Give us back money,’” he recalled. “And so DPI became the thing to talk about.”

LP Responses to DPI

Investor Sophistication and Resources

Despite DPI’s increased popularity post-pandemic, it has still not come close to phasing out other methodologies, Randall asserted. “We have the big three performance metrics, which are IRR, TVPI and DPI, and all three are critical to assessing historical fund performance. If I was forced to rank, I would say that IRR is our most important, as that is ultimately how we are measured, with DPI second and TVPI third. But again, all are important, and no single metric tells the full story.”

The measured approach that many investors take to DPI speaks to the fairly sophisticated grasp that many investors have of how different performance metrics complement one another, as well as what each does and does not capture, in Richman’s view. “It’s difficult to lump all investors into the same pool, but institutional investors that represent some of the most sophisticated financial institutions in the world have fully built out investment and finance teams,” he said. “I would presume that they evaluate the different metrics – RVPI, TVPI and DPI.”

“When a manager does not provide DPI calculations, some large investors may nevertheless be able to extract the requisite data from a manager to calculate it themselves because of their commercial importance to the manager and their seat on the fund’s [LP advisory committee]. However, smaller LPs may not be able to access that same information,” Richman said.

Concerns About High DPI

When assessing the prominence of DPI relative to other metrics, it is worth noting that some investors do not seek constant high returns or value DPI as a measure of how well a fund meets that expectation, Randall clarified. In fact, some investors rely on DPI to let them know when distributions are actually higher than desired, he pointed out.

One voice could be a large institutional investor like TRS that does not mind receiving early distributions. “We would tell a manager, ‘We’re over our target allocation, but we’re happy with a certain level of velocity because we have the resources to reinvest the money.’ We don’t get stuck with a cash drag when the dollars come back,” Randall posited. On the other hand, a smaller investor like a family office may be more sensitive to money coming back early because the proceeds would sit around longer before being redeployed, he observed. “A family office might say, ‘Oh, you sent me money back. Now I have to figure out what to do with it. I wish you had just held it for 15 years. I didn’t really need it as long as you gave me a big return on the back end.’”

The bifurcated reaction among investors might make sense from their point of view, but at the same time poses problems for fund managers, Randall explained. “It’s not an issue for everyone, but I could see how managers would struggle when hearing those two opposing voices around what’s important.”

Retail Vulnerability

The narrative of the growing use of DPI and its utility for investors becomes far more complicated when one considers the vast and diverse market of investors in private funds, Richman continued. The data rooms and algorithmic savvy that institutional investors put to use are not typically at the disposal of a segment of growing importance to the PE market, namely, retail investors, he said.

“At the far end of the spectrum away from institutional investors, you have retail investors who have their money invested through a wirehouse or a local registered investment adviser,” Richman posited. “Suppose that adviser has made a commitment of $15 million to a PE fund.” In that scenario, the small investor may not be privy to which metrics, if any, are used to evaluate the fund’s performance. The investor can attempt to self-calculate DPI, though such methodology can be prone to blind spots and cause misleading results.

See “Inherent Obstacles and Promising Pathways to Retailization in the PE Industry” (May 29, 2025); and “Legal Due Diligence Considerations for HNWIs and Family Offices Investing in Closed‑End Private Funds” (May 1, 2025).

Among their other regulatory obligations, private fund managers that are SEC-registered investment advisers (RIAs) may be subject to Form PF reporting obligations pursuant to Rule 204(b)‑1 under the Investment Advisers Act of 1940. Since its adoption in 2011, Form PF remained relatively unchanged. Recently, however, the SEC renewed its focus on the form, amending it three times since 2023 and bringing enforcement actions against investment advisers for Form PF violations. Following the amendments to the form, the SEC staff published updated and new responses to frequently asked questions (FAQs) in late 2024 and early 2025.

The updated FAQs highlight many of the significant changes to Form PF introduced by the amendments and illustrate how certain Form PF filers may need to revamp their approach to completing the form, which managers should promptly address regardless of the SEC’s decision to extend the compliance date for the latest amendments until October 1, 2025. This article analyzes the FAQ changes most relevant to PE sponsors, including why those that advise – or that have a related person that advises – fund-of-funds, parallel fund structures, parallel managed accounts or master-feeder arrangements need to carefully reconsider their Form PF reporting obligations.

See “Potential Areas of Scrutiny in Future SEC Examinations of PE Sponsors” (Jan. 9, 2025).

Amendments of Form PF

During Gary Gensler’s tenure as SEC Chairman, the SEC amended the form on three occasions. The amendment published on May 3, 2023 (First Amendment), updated Form PF to require, among other changes, any Form PF filer that advises PE funds to file “current” reports within 60 calendar days after the end of the fiscal quarter to report the occurrence of certain triggering events. It also updated the form to require “current” reporting for “Large Hedge Fund Advisers” within 72 hours of certain triggering events as to qualifying hedge funds managed by those advisers.

See this two-part series on the First Amendment: “Key Provisions for PE Sponsors and Relevant Departures From the Proposal” (Jun. 29, 2023); and “Overarching Takeaways and Suggestions for How PE Sponsors Can Prepare to Comply” (Jul. 13, 2023).

In the amendment published on July 12, 2023 (Second Amendment), the SEC further amended Form PF to align certain liquidity fund reporting requirements with money market fund reporting. In the amendment published on February 4, 2024 (Third Amendment), the SEC amended Form PF to require:

• additional reporting about investment advisers and the private funds they advise, including information about:
  • withdrawal and redemption rights;
  • gross asset value and net asset value (NAV);
  • inflows and outflows;
  • borrowings and types of creditors;
  • fair value hierarchy;
  • beneficial ownership; and
  • fund performance;
• more details about hedge fund investment strategies, counterparty exposures, and trading and clearing mechanisms employed by hedge funds; and
• separate reporting for each component fund of master-feeder arrangements and, in most cases, parallel fund structures.

The changes adopted in the First and Second Amendments have already taken effect. As for the Third Amendment, however, the SEC recently extended the compliance date a second time from June 12, 2025, to October 1, 2025. The SEC also noted in the release announcing the compliance date extension that it may continue to review whether Final Form PF raises substantial questions of fact, law or policy, which suggests that the SEC could make further changes to Form PF in the future.

SEC efforts related to Form PF have not been limited to the aforementioned amendments. After the three amendments were published, the SEC also brought enforcement actions against investment advisers for violations of Form PF in 2024, and included the amendments to Form PF in its 2025 examination priorities. It remains unclear, however, whether Form PF will remain an enforcement priority under new SEC leadership. With that said, the SEC historically has focused its enforcement and examination efforts on compliance with newly adopted rules regardless of the political composition of the SEC.

See “SEC 2025 Examination Priorities Feature Essential Compliance Concerns, Emerging Technologies and Several Notable Omissions” (Dec. 12, 2024).

Overview of Form PF

Any RIA that has, together with its related persons (except those that are separately operated), $150 million or more in assets under management (AUM) attributable to private funds as of the last day of its most recently completed fiscal year must file a Form PF with the SEC (Form PF Filers).

Form PF is comprised of six substantive sections. All Form PF Filers must complete Section 1.

• Section 1a: Asks for general identifying information about the investment adviser and the types of private funds it advises.
• Section 1b: Asks for identifying and other information about each private fund that the Form PF Filer advises, including information about each fund’s assets, investors and performance.
• Section 1c: Asks for additional information about any “hedge fund” advised by the Form PF Filer, including information about any such fund’s investment strategy and counterparty exposure.

As outlined below, a Form PF Filer may be subject to additional reporting requirements for certain funds, depending on a fund’s category and amount of assets.

Large PE Fund Advisers

A Form PF Filer that is a “Large Private Equity Fund Adviser” must complete Section 4 of Form PF as to each “private equity fund” (as defined below) it advises, including as to any master-feeder arrangements and parallel fund structures (which, for purposes of Section 4, may be reported collectively or separately). An investment adviser is a Large Private Equity Fund Adviser if it and its related persons (except those that are separately operated), collectively, had at least $2 billion in AUM attributable to private equity funds as of the last day of its most recently completed fiscal year.

A Large Private Equity Fund Adviser must also complete, within 60 days after each quarter-end, “current reports” on Section 6 of Form PF for each private equity fund it advises, if the following occurs as to a fund:

• an adviser-led secondary transaction;
• the fund’s GP is subject to removal; or
• investors elect to terminate the fund or its investment period.

Within 120 calendar days after the end of its fiscal year, a Large Private Equity Fund Adviser – and any other Form PF Filer that is not a Large Liquidity Fund Adviser or a Large Hedge Fund Adviser – must file an annual amendment to Form PF that updates responses to all items of the form.

See “Conflicts of Interest in an Evolving Landscape: Potential Areas of SEC Examination Risk for GP‑Led Secondary Transactions” (Mar. 20, 2025).

Large Hedge Fund Advisers

A “Large Hedge Fund Adviser” is any investment adviser that, collectively with its related persons, had at least $1.5 billion in hedge fund AUM as of the last day of any month in the fiscal quarter immediately preceding its most recently completed fiscal quarter.

A Large Hedge Fund Adviser must complete Section 2 of Form PF as to each “qualifying hedge fund”^[1] it advises. The Form PF Filer must also complete a separate Section 2 for:

• each parallel fund that is part of a parallel fund structure that, in the aggregate, comprises a qualifying hedge fund (even if that parallel fund is not itself a qualifying hedge fund); and
• the master fund of any master-feeder arrangement that, in the aggregate, comprises a qualifying hedge fund (even if that master fund is not itself a qualifying hedge fund).

Within 60 calendar days after the end of each calendar quarter, a Large Hedge Fund Adviser must file a quarterly update to Form PF that updates the answers to all items relating to the hedge funds that it advises.

A Large Hedge Fund Adviser must also complete “current reports” on Section 5 of Form PF for each hedge fund that it advises no later than 72 hours after the occurrence of certain specified events:

• certain extraordinary investment losses (i.e., 20 percent or more of a fund’s most recent NAV);
• significant margin and counterparty default events;
• material changes in prime broker relationships;
• certain operational events;
• certain large withdrawal or redemption activity; or
• the fund is unable to satisfy redemptions, or suspends redemptions, for more than five consecutive business days.

Large Liquidity Fund Advisers

A Form PF Filer must complete Section 3 of the form if:

• it advises one or more “liquidity funds” (i.e., a private fund that seeks to generate income by investing in a portfolio of short-term obligations in order to maintain a stable NAV per unit or to minimize principal volatility for investors); and
• as of the last day of any month in the fiscal quarter immediately preceding its most recently completed fiscal quarter, it and its related persons, collectively, had at least $1 billion in AUM attributable to money market funds (within the meaning of Rule 2a‑7 under the Investment Company Act of 1940) and liquidity funds (Large Liquidity Fund Adviser).

Within 15 calendar days after the end of each calendar quarter, a Large Liquidity Fund Adviser must make a quarterly filing that updates the answers to all items relating to the liquidity funds that it advises.

Impact of New FAQs and Related Form PF Amendments for PE sponsors

Timing for Filing of Amended Form PF

As mentioned, the SEC extended the compliance date for the changes to Form PF adopted in the Third Amendment (Amended Form PF) to October 1, 2025. As a result, Form PF Filers with a December fiscal year-end that only file Form PF on an annual basis (i.e., are not Large Hedge Fund Advisers or Large Liquidity Fund Advisers) will not need to complete the Amended Form PF until the annual amendment due by April 30, 2026. Large Hedge Fund Advisers and Large Liquidity Fund Advisers, which are required to file Form PF on a quarterly basis, will need to use the newest version of Form PF for filings due in the fourth quarter of 2025.

In Question A.7 of the FAQs, the SEC staff clarified that a Form PF Filer is not required to update information on Form PF that it believes – in good faith - was properly responded to on the date of filing and, thus, would not be required to correct or amend any response that is rendered inaccurate solely as a result of the Third Amendment becoming effective. In that instance, the SEC staff recommends that the Form PF Filer provide an explanation in response to Question 4 of Form PF to indicate the amended responses and any assumptions.

Fund and Investment Adviser Characterization

Form PF Filers, and especially PE sponsors, must pay close attention to the applicable categorization for each private fund it (or, in some cases, a related person) advises, as that categorization may dictate whether the filer triggers the additional Form PF reporting thresholds (e.g., as a Large Private Equity Fund Adviser, Large Hedge Fund Adviser or Large Liquidity Fund Adviser).

Further, the definitions for the applicable fund categories do not necessarily align with conventional terminology or how a Form PF Filer may market its fund. For purposes of Form PF, a “private equity fund” is any private fund that is not a “hedge fund,” “liquidity fund,” “real estate fund,” “securitized asset fund” or “venture capital fund” (as those terms are defined in the form) and does not provide investors with redemption rights in the ordinary course.

See this two-part series on hybrid funds: “Key Benefits and Different Liquidity Mechanisms to Unlock Them” (Oct. 3, 2024); and “Practical Challenges and Potential Conflicts of Interest” (Oct. 17, 2024).

As a threshold matter, a PE sponsor must assess whether any fund it manages could meet the definition of a “hedge fund.” As noted above, if a private fund meets the definition of a hedge fund, the Form PF Filer may be a Large Hedge Fund Adviser and subject to quarterly reporting obligations and more detailed reporting in response to the sections of the form applicable to hedge funds (e.g., Sections 1c, 2 and/or 5). The definition of a “hedge fund” includes any private fund (other than a securitized asset fund) that meets any of the following conditions:

1. As to the fund, one or more investment advisers (or their related persons) is paid a performance fee or allocation calculated by taking into account unrealized gains (other than a fee or allocation may be calculated using unrealized gains solely for the purpose of reducing the fee or allocation to reflect net unrealized losses);
2. The fund borrows an amount in excess of one-half of its NAV (including any committed capital) or has gross notional exposure exceeding twice its NAV (including any committed capital); or
3. The fund sells securities or other assets short or enter into similar transactions, other than for the purpose of hedging currency exposure or managing duration.

An investment adviser’s characterization of the fund is not determinative, however. Per Question E.1 of the FAQ, a private fund would be a “hedge fund” for purposes of Form PF if the fund’s operative documents permit the fund to incur leverage or sell assets short as described above – even if the fund does not do so in practice.

Further, the FAQs explain that the applicable category for a private fund may change (e.g., due to changes to the fund’s limited partnership agreement), in which case a Form PF Filer must reevaluate the fund’s appropriate categorization and thus whether the Form PF Filer meets any additional Form PF reporting thresholds. Although the SEC took that position in the original adopting release for Form PF, managers must remain mindful of those distinctions given the more onerous reporting requirements in the Amended Form PF – especially as to hedge funds.

That analysis can be further complicated by whether the investment adviser is affiliated with other investment advisers. A Form PF Filer must attribute to itself any private funds and parallel managed accounts advised by a related person (including related persons that the Form PF Filer has not identified in Question 1(b) as related persons for which it is filing Form PF), unless the related person is “separately operated.” For purposes of Form PF, a related person is separately operated if the Form PF Filer is not required to complete Section 7.A. of Schedule D to Form ADV as to that related person.^[2]

That determination requires a factual analysis, and a Form PF Filer should maintain internal documentation to support that analysis and ensure its Form PF and Form ADV filings report consistent information. An investment adviser that can exclude a related person’s AUM on that basis can potentially alleviate some of the Form PF reporting burdens that apply at the additional reporting thresholds. Note, however, that any related person that is not reflected in the Form PF Filer’s filing must independently assess its own Form PF filing obligation.

Trading Vehicles and Related Issues

The changes adopted in the Third Amendment will require Form PF Filers to identify any “trading vehicles” of a reporting fund and aggregate those vehicles with the reporting fund when responding to the questions in Amended Form PF. A trading vehicle is defined as any separate legal entity, wholly or partially owned by one or more reporting funds, that holds assets, incurs leverage, or conducts trading or other activities as part of a reporting fund’s investment activities but does not operate a business.

In Question A.9 of the FAQ, the SEC clarified that even if an investment adviser previously reported a vehicle as a “private fund” on Form PF, the investment adviser will need to treat it as a trading vehicle on the Amended Form PF if it meets the above definition. The SEC staff also recommends that the Form PF Filer, on the first filing on the Amended Form PF after the compliance date, could indicate in Question 4 that an entity previously reported as a separate reporting fund is now being reported as a trading vehicle.

Form PF Filers will need to continue to “look through” a trading vehicle’s holdings for Form PF reporting purposes; however, amended Form PF will require a Form PF Filer to:

• identify any trading vehicle;
• address how the reporting fund uses the trading vehicle(s); and
• report the position sizes and counterparty exposures of the reporting fund that are attributable to the trading vehicle(s).

Thus, a Form PF Filer that manages any funds that hold underlying portfolio companies through intermediate holding vehicles may need to revisit how it identifies those vehicles and respond to certain questions in their Amended Form PF.

Aggregation of Certain Fund Structures

In a change from the prior version of the form, Amended Form PF will generally require separate reporting for each component fund of a master-feeder arrangement and parallel fund structure (other than a disregarded feeder fund). That is, a Form PF Filer will no longer have the option to report those funds on an aggregated basis. Thus, while master-feeder arrangements and parallel fund structures must be aggregated when determining whether an investment adviser meets any Form PF reporting threshold, the Amended Form PF generally will require those arrangements and structures to be reported on a disaggregated basis. In response to those changes, the SEC staff withdrew several responses to prior FAQs that explained how a Form PF Filer could respond to certain Form PF questions on an aggregated basis for master-feeder and parallel fund structures.

See “Beyond the Master-Feeder: Managing Liquidity Demands in More Flexible Fund Structures” (May 25, 2017).

On Amended Form PF, a Form PF Filer does not need to report a feeder fund (a “disregarded feeder fund”) that invests all of its assets in:

• a single master fund;
• U.S. treasury bills; and/or
• cash and cash equivalents.

In that case, however, the Form PF Filer must identify whether each feeder fund is a disregarded feeder fund in Question 7 of Form PF and “look through” to the disregarded feeder funds’ investors when responding to certain questions about the composition of those investors. That can present challenges for PE sponsors with unique fund structures. For example, in a master-feeder structure where a feeder fund is sponsored by a third party, a Form PF Filer will need to coordinate with the third party to obtain information about the feeder fund (e.g., the composition of its investors) to respond to the relevant questions in the Amended Form PF.

In addition, changes adopted in the Third Amendment prevent Form PF Filers from separately reporting any “parallel managed accounts,” provided the Form PF Filer will continue to report the total value of all parallel managed accounts related to each reporting fund. However, a Form PF Filer must aggregate any “dependent parallel managed account” with the largest private fund to which it relates when determining Form PF reporting thresholds. Form PF defines a dependent parallel managed account as any related parallel managed account other than a parallel managed account that individually (or together with other parallel managed accounts that pursue substantially the same investment objective and strategy and invest side by side in substantially the same positions) has a gross asset value greater than that of the private fund (or, if the private fund is a parallel fund, the gross asset value of the parallel fund structure).

Taken together, PE sponsors that advise master-feeder and parallel fund structures will need to reassess how they address those arrangements on Amended Form PF, including whether and how any parallel managed accounts advised by the Form PF Filer or a related person affect the form’s additional reporting thresholds and other responses to the form.

Fund‑of‑Funds Reporting

Form PF Filers will no longer have the option to disregard underlying funds in a fund-of-funds structure as they did under the prior version of Form PF when responding to certain questions and the additional reporting thresholds. The SEC staff withdrew several responses to prior FAQs that addressed how to respond to certain questions in the form based on that prior flexibility.

Importantly, a Form PF Filer must include the value of private fund investments in other private funds – both “internal” (i.e., advised by the Form PF Filer or a related person) and “external” private funds – when determining whether it is required to file Form PF and whether it meets the form’s additional reporting. Thus, a PE Sponsor that advises fund-of-funds (or that has a related person that advises fund-of-funds), and had previously disregarded underlying funds for Form PF reporting purposes, should reevaluate how those underlying funds will impact the additional reporting thresholds.

In a change from the prior version of the form, the instructions to Amended Form PF require a Form PF Filer to not “look through” a reporting fund’s investments in “internal” or “external” private funds (other than a trading vehicle) when responding to questions, unless the question instructs the Form PF Filer to report exposure obtained indirectly through positions in those funds or other entities.

See this two-part series on closed-end funds of PE funds: “Relative Merits of Registration Options and an Infinite‑Life Structure” (Jun. 2, 2020); and “Considering Bespoke Valuation, Co‑Investment, Director and Tax Issues” (Jun. 16, 2020).

Conclusion

As the compliance date for the Third Amendment approaches, PE sponsors should reevaluate how the recent changes to the form and FAQs apply to the funds and accounts they manage, as well as those managed by related persons. For certain PE sponsors, the changes may result in new Form PF reporting thresholds that trigger more frequent and/or onerous reporting obligations. More time and resources should be allocated to completing Form PF going forward, especially by PE sponsors that need to overhaul how they report master-feeder arrangements, parallel fund structures, parallel managed accounts and fund-of-funds.

 

Kelley A. Howes is a partner in the Denver office of Morrison Foerster. She advises U.S.-registered investment companies (including mutual funds, exchange traded funds and interval funds), business development companies, RIAs and exempt reporting advisers (ERAs) on a wide range of legal, regulatory and compliance matters. She also counsels clients on investment company status matters under the Investment Company Act of 1940.

Aaron J. Russ is an associate in the Washington, D.C., office of Morrison Foerster. He advises private fund managers, wealth managers, innovative investment advisory fintech firms, and other RIAs and ERAs on various regulatory and compliance issues that arise in connection with operating an advisory business, including compliance with the federal securities laws.

In August 2024, the Financial Crimes Enforcement Network (FinCEN) adopted final rules (AML Rules) that will impose the anti-money laundering (AML) and countering the financing of terrorism (CFT) requirements of the Bank Secrecy Act of 1970 (BSA) on certain investment advisers (Covered Advisers). Although a related rule proposal on customer identification programs (CIPs) has not been finalized yet, the AML Rules are scheduled to come into effect on January 1, 2026.

To help investment advisers prepare to comply with the AML Rules, EisnerAmper and Lowenstein Sandler recently presented a webinar, entitled “What Investment Advisers Need to Know: New AML/CFT Compliance Requirements,” which featured Lowenstein Sandler partners Scott H. Moss and Robert A. Johnston, as well as EisnerAmper partner Louis Bruno and managing director Isatou Smith. This article summarizes key takeaways from their discussion.

For additional insights from Lowenstein Sandler, see “Limited AI and Alternative Data Adoption for Legal and Compliance Efforts, According to Survey” (May 1, 2025); and from EisnerAmper, see “What Investors Should Look for When Scrutinizing PE Sponsors’ Audits During ODD” (Feb. 20, 2025).

Current Rules and Regulations

MLCA

All U.S. companies and persons are subject to the Money Laundering Control Act of 1986 (MLCA), which criminalizes engaging – or attempting to engage – in financial transactions with the intent to promote specified unlawful activity or to conceal the fact that transaction proceeds are the proceeds of crime, Johnston noted. There is no minimum dollar threshold for MLCA violations, he added.

Knowledge is a criterion for violations, which includes “willful blindness” or “conscious disregard” of the high likelihood that criminal activity is occurring, Johnston observed. As a result, ignoring red flags or turning a blind eye may be sufficient to establish culpability in a jury trial.

OFAC Regulations

In addition, all U.S. persons and companies are subject to the sanctions programs administered by the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC), Johnston said. There are a variety of sanctions programs, including:

• comprehensive jurisdictional prohibitions – e.g., against any company or person located in Cuba, Iran, North Korea or Syria;
• Specially Designated Nationals and Blocked Persons list (SDN List), which is a frequently updated (at least weekly) registry of sanctioned individuals and entities; and
• 50% rule, whereby an entity is subject to sanctions if at least 50% of that entity is owned by one or more sanctioned persons/entities.

Any transaction using U.S. dollars is subject to OFAC prohibitions, so they have broad extraterritorial reach, Johnston continued. For example, a French company operating a cement factory in Lebanon and Syria was prosecuted for OFAC violations because payments made to ISIS were in U.S. dollars and would have cleared through a correspondent bank in the U.S., which the U.S. authorities determined was a sufficient nexus for criminal liability, he elaborated.

Criminal violations of OFAC sanctions require knowledge, including willful blindness or conscious disregard, Johnston noted. There is strict liability for civil violations and there is no minimum dollar amount required, but OFAC may take into account the existence of a reasonably designed and implemented sanctions compliance program as a mitigating factor. At minimum, investment advisers should be periodically screening all counterparties, investors, borrowers and vendors against the SDN List, he recommended.

See our three-part series on sanctions: “How Sanctions Regimes Work” (Sep. 13, 2022); “Their Impact on Private Fund Investors and Investments” (Sep. 20, 2022); and “How to Comply With Them” (Sep. 27, 2022).

PATRIOT Act

The government also promulgates special measures under Section 311 of the USA PATRIOT Act, which Covered Advisers will need to comply with, Johnston said. For example, networks in Cambodia and Myanmar were recently designated as primary money laundering concerns, which means financial transactions with those entities must cease.

In addition, pursuant to Section 314 of the PATRIOT Act, law enforcement agencies may require Covered Advisers to promptly provide records and documents relating to a person/entity under investigation. When an institution is investigating suspicious activity, there is a safe harbor under Section 314(b) if information is shared with another entity that is also subject to the BSA (e.g., a broker dealer) about a specific transaction being reviewed, he added.

New Requirements

AML Rules

Certain SEC-registered investment advisers (RIAs) and exempt reporting advisers (ERAs) are Covered Advisers under the AML Rules and will need to establish AML programs that satisfy BSA requirements, Johnston noted. The AML Rules require Covered Advisers to monitor suspicious activity and file suspicious activity reports (SARs) as well as currency transaction reports (CTRs) when they deal with physical currency or cash equivalents, he said.

Covered Advisers will also need to comply with the Recordkeeping and Travel Rules, which include rules for records relating to wire transfers, Johnston continued. Know your customer (KYC) or customer identification records must be retained for five years after the client relationship ends. For example, if a person opened a bank account in 2005, the bank should have had that customer’s identification records for 20 years and would need to keep them for another five years after the account is closed, he noted.

See our two-part series on the AML Rules: “Parsing FinCEN’s Final AML Rules for Investment Advisers” (Jan. 23, 2025); and “Understanding the Implications for Fund Managers of FinCEN’s Final AML Rules” (Feb. 6, 2025).

Proposed CIP Rule

In May 2024, FinCEN and the SEC proposed a joint rule that would require RIAs and ERAs to implement CIPs (Proposed CIP Rule), Johnston commented. Arguably, CIPs are the most important pillar in a BSA program, so it may be difficult for the industry to start to put in place the BSA program required under the AML Rules before the Proposed CIP Rule is finalized, he said.

See “FinCEN and SEC Issue Proposed Customer Identification Program Requirements for Investment Advisers” (Jun. 27, 2024).

The Proposed CIP Rule would require investment advisers to implement “risk-based” and “reasonable” procedures to verify the identity of any person seeking to open an account within a “reasonable time” before or after the customer’s account is opened, Johnston noted. The verification records would need to be retained for at least five years following account closure. As proposed, the customer is defined as the entity or person having a contractual relationship with the investment adviser, but FinCEN subsequently promulgated FAQs clarifying that the requirements were intended to apply to underlying investors, he added.

Assuming the Proposed CIP Rule is adopted and the definition is changed, RIAs and ERAs will need to collect information from investors and advised clients to establish their:

• full legal name;
• date of birth/date of formation;
• address; and
• identification number (e.g., employer identification number, Social Security number or passport).

Additional information will need to be obtained as part of the KYC process where there are higher risks, Johnston noted.

It is possible to rely on a third party to meet the CIP requirements, provided that third party is a financial institution that is subject to the BSA or a substantially similar regulation, Johnston commented. There must be a contractual relationship between the adviser and the third-party financial institution that expressly gives the adviser the right to rely on the work the financial institution is performing, and the adviser must have the right, upon demand, to access underlying KYC records, he explained.

It is apparent from the implementing releases for both the AML Rules and Proposed CIP Rule that the perceived problem they aim to address is the high risk of individuals and entities entering the U.S. financial system as LPs, Johnston continued. The Proposed CIP Rule as currently drafted may not resolve the problem, however, and that could be contributing to delays in finalizing the rule, he speculated. “There has also been a change in administration, with new senior people seated at both the U.S. Department of Treasury and the SEC. Now that those people are all confirmed and in place, perhaps the [Proposed CIP Rule] will be finalized.”

See “FBI Sees Significant Risk That Private Funds Are Exploited for Money Laundering” (Dec. 15, 2020).

Open Issues

Nebulous Effective Dates

The effective date for the AML Rules is January 1, 2026, so investment advisers should have a fully operational BSA compliance program before then because there will be affirmative obligations (e.g., to monitor suspicious activity and file SARs) from that date, Johnston said.

On the other hand, the Proposed CIP Rule has not been finalized, despite the express intent for it to become effective at the same time as the AML Rules, Moss noted. Numerous industry groups have written to the SEC and FinCEN urging the regulators, at a minimum, to extend the compliance date for the AML Rule to at least coincide with the final CIP rule’s effective date. It makes sense to have one effective date for both rules because they are related, and the compliance policies and procedures will be connected, he explained.

Along those same lines, industry groups have also called for an additional comment period to be opened on the AML Rule because the Proposed CIP Rule has not been finalized and comments should be permitted on both rules, Moss continued. Industry groups would like to revisit facilitating risk-based approaches and reducing duplicative burdens. For example, if a managed account adviser’s clients all open brokerage or bank accounts, the brokers and banks are already subject to the BSA. Therefore, it seems unnecessary for the adviser to duplicate the qualified custodians’ efforts to meet BSA requirements, he elaborated.

“At a minimum, most of the market expects the compliance date to be pushed back, but nobody knows exactly if and when that’s going to happen,” Moss observed. It would also not be surprising if there is an additional comment period as well. In addition, industry groups have asked for an 18- to 24‑month transition period once both the CIP rule and a potentially modified AML Rule are finalized, he added. It may be necessary, however, for investment advisers to draft compliance programs, policies and procedures in case the AML Rules become effective from January 1, 2026.

Enforcement Uncertainty

FinCEN is the examiner for compliance with the BSA and, historically, has been leanly staffed, Johnston noted. However, FinCEN has outsourced its examination powers to the SEC. “It is highly likely, given the SEC has its own Division of Examinations, that RIAs will be examined on their compliance with the AML Rules. It remains to be seen if that will be part of a standard, routine exam, or if the SEC will perform targeted examinations starting in 2026 when the rule is effective,” he said.

The SEC does not have a routine examination program for ERAs, and they are typically examined only when there is cause to do so, Moss explained. Similarly, ERAs are not subject to all the rules and regulations that apply to RIAs, including appointing a CCO or maintaining a more fulsome compliance manual. It seems somewhat unusual for ERAs to be included in more stringent regulations under the AML Rules but exempt from some exacting regulations under the Investment Advisers Act of 1940 (Advisers Act), he observed.

See “SEC Penalizes Firms for AML‑Related Violations” (Mar. 6, 2025).

Preparing for New Requirements

As the compliance date for the AML Rules draws closer, advisers are reevaluating the new requirements and what it means to have a risk-based compliance program, Bruno said. There are some helpful standards that can be leveraged, including the “five pillars” framework that has been in place and defined for years, he noted.

Five Pillars of an AML Compliance Program

Bruno outlined the five pillars of an AML compliance program as follows:

1. Designated Compliance Officer: A qualified senior manager should be designated to oversee the AML program. It is important that the designated person not only understands the AML requirements under the BSA but can also be the point person for the program.
2. Policies, Procedures and Controls: Comprehensive written policies and procedures should be maintained. It is imperative to define the firm’s risks and specify how the AML program is designed to mitigate those risks.
3. Periodic Independent Testing: To be independent, testing should be carried out by an internal audit team or a third party.
4. Periodic Training: Training should be carried out at least annually to ensure all employees are aware of the risk to the firm and understand their responsibilities.
5. Customer Due Diligence Program: The program should effectively establish and verify the identity of investors and beneficial owners, including monitoring and identifying changes to relationships and identifying any specific suspicious activities.

The only pillar that cannot be outsourced is the designated AML compliance officer, who must be a human employee of the RIA or ERA, Johnston added.

Risk‑Based Compliance Program

A risk-based approach to compliance is intended to give investment advisers flexibility to design controls that specifically mitigate the firm’s risk, Bruno explained. The following are some best practices for creating a risk-based compliance program.

Define the Risks Profile and Risk Tolerance

When defining their firm’s risks, advisers should consider their business activities, which may include channels where the adviser does not necessarily know or interact with the underlying investor – e.g., fundraising activities via third parties or some advisory relationships.

It is also important to consider the types of advisory clients involved with the firm and the investment vehicles that are set up, Bruno stated. As an example, exchange-listed closed-end funds may be considered lower risk because they are traded primarily through broker-dealers or banks that are subject to the BSA. Private funds may also be considered lower risk because they may have lower subscription amounts or restrictions on redemptions, he said.

There has been a lot of discussion in the industry about separately managed accounts (SMAs) because they may have limited transparency and greater liquidity options compared to pooled investment vehicles, Bruno continued. As a result, SMAs may attract bad actors, and it is important to consider that when defining the risks. Real estate funds may also present higher risks, given the complexity of the legal entities and ownership structures, which can make it more difficult to identify origins of funds, he added.

Looking at the underlying investor risks, advisers may consider whether investors come from high-risk jurisdictions for money laundering or conduct high-risk business activities (e.g., casino operators or precious metal dealers), Bruno said. Politically exposed persons (PEPs) and those affiliated with them should also be considered in the risk matrix, he noted.

See “Unifying Risk Assessments: Breaking Silos to Enhance Efficiency and Manage Risk” (May 29, 2025).

Document AML/CFT Policies

At minimum, advisers should have written policies and procedures that:

• describe the regulatory requirements;
• define the firm’s risks;
• outline controls tailored to mitigate those risks;
• specify the consequences of violating the policy; and
• describe the oversight and the role of management in supporting the policies.

“The ultimate goal of defining the risk is to create the right policies and procedures,” Bruno emphasized.

Develop Controls to Mitigate the Risks

The adviser should designate an AML officer or someone who is responsible for the AML program, and controls should be defined, Bruno said. It is helpful to create an inventory of controls and monitoring requirements to ensure there are control processes in place to support the written policies. Inventories range from simple spreadsheets to being incorporated into risk management technology. Ongoing monitoring should be conducted to identify and report suspicious transactions, and to maintain and update customer information on a risk basis, he noted.

Define Training

A training program should be defined based on the firm’s risk profile, Bruno commented. Oftentimes, off-the-shelf training is used, which does not really address the firm’s policies, he added.

Conduct Independent Testing

Testing may be carried out by an independent internal audit team or outsourced to a third party, Bruno said. The firm’s risk assessment and controls inventory may help define the scope of the internal or external auditor’s engagement. Developing a “right size” compliance program to mitigate specific risks is not straightforward, and requires considerable commitment from senior management, HR and technology, he emphasized.

It is critical that the testing is independent, Johnston noted. RIAs that are currently subject to annual review and CCO reporting may test their AML program to ensure compliance with Rule 206(4)‑7 under the Advisers Act, but that will not satisfy the independent testing requirement. “FinCEN was very clear in their written guidance in response to questions that independent testing means an entity or a division separate and apart from the entity or division performing or responsible for AML,” he said.

See “Compliance Program Implementation: Compliance Calendars and Testing” (Sep. 5, 2024).

Red Flags

Advisers should define specific warning signs of possible money laundering or terrorism financing through the business life cycle, Bruno noted. It is important to understand that red flags are not definite proof of wrongdoing but can alert advisers to areas that warrant further investigation and potential reporting, he clarified.

Warning signs will be unique to each adviser and their business model, Bruno clarified, but he highlighted several red flags that may arise during the subscription stage.

• There is negative news about the investor or affiliated parties.
• The investor has difficulty describing the nature of their business or lacks general knowledge of the industry their business is engaged in.
• The investor appears to be controlled or owned by a senior political figure or PEP.
• The investor seems to be avoiding providing standard KYC documentation.
• The investor appears to be acting as the agent for another entity but is reluctant, without legitimate commercial reasons, to provide information about that entity.

In addition, Bruno outlined examples of red flags that may occur throughout the investment process and the life of a fund.

• An investor wishes to engage in investments that are inconsistent with its staged investment strategy or previous investments.
• The investor requests full liquidation or otherwise issues redemption requests that are not necessarily in line with agreements or that may seem suspicious.
• An investor lacks any concern about the investment program, related risks, the management team and other important issues.
• An investor makes economically irrational decisions or decisions misaligned with their investment thesis.
• The investor makes unusual transactions related to third parties – e.g., changing bank account information during redemptions.

Suspicious Activity Reporting

Covered Advisers must file a SAR within 30 days of becoming aware of suspicious activity, which is a tight time frame, Johnston said. A SAR is required for potential criminal violations, involving:

• insider abuse (for any amount);
• $5,000 or more when a specific individual can be identified; and
• $25,000 or more, regardless of whether a specific individual can be identified.

Investments advisers will almost always be over the minimum reporting thresholds, Johnston noted. Importantly, the transaction does not need to be consummated for reporting obligations to arise. “Any suspicious transaction or potentially criminal transaction, either conducted or attempted by or through the financial institution or one of its affiliates, would need to be reported if it involves potential money laundering or potential illegal activity designed to evade the BSA,” he said.

For example, a customer that is aware of the currency transaction reporting rules might perform a $20,000 cash deposit by depositing $5,000 in four different branches, or the customer may make a transaction it would not normally be expected to engage in, Johnston continued. KYC programs are important for building an expected risk profile and transaction profile for customers in order to detect unusual behavior, he added.

The threshold for filing a SAR is relatively low, Johnston observed. When in doubt, most institutions tend to file a SAR because filings must be kept strictly confidential. The subject of the filing may never know that a SAR was filed and, in any event, would be barred from taking any action, provided the SAR was filed in good faith. On the other hand, if the government discovers an institution was aware of suspicious activity but did not file a SAR, then the institution may be charged with BSA violations, he noted.

There are criminal penalties associated with tipping off a bad actor about a SAR filing, Johnston continued. For example, if an institution was considering filing a SAR as to an LP, and the relationship manager in investor relations told the LP about the internal review or SAR filing, that would be a criminal act. To minimize that risk, most financial institutions keep information about potential and/or filed SARs within a very limited group of people in the compliance or legal department. “You should think about ways to permission the recordkeeping to the very small group of people that need to know about the SAR’s existence,” he recommended.

Outsourcing Compliance Activities

Using Third‑Party Support

AML functions that can potentially be outsourced include:

• investor due diligence;
• customer identification;
• sanctions and terrorist watchlist screening;
• suspicious transaction monitoring;
• filing CTRs and SARs;
• responding to law enforcement requests under the PATRIOT Act; and
• maintaining required records.

Advisers can delegate any component of their AML program, except the AML officer, which must be an in-house employee, Smith said. A key point about outsourcing is that the adviser is ultimately responsible and will be liable for any deficiencies, notwithstanding delegation or reliance on a third party. It is therefore vital that testing is carried out on parties that are performing any part of an AML compliance program, she emphasized.

Smith explained that an adviser may have a policy that states it is relying on the steps of an administrator, but the adviser should take steps to confirm that it can rely on the administrator, e.g., carrying out checks on the administrator at the outset and regularly testing the administrator’s program. A risk-based approach may be taken, so an unregulated administrator in the U.S. may require more oversight than a regulated administrator in the Cayman Islands that is already subject to most of the incoming AML requirements. It is also important to document the checks and testing, she added.

See “Managing Risks Associated With Outsourcing” (Nov. 2, 2023).

Leveraging Cayman Islands Compliance Programs

Advisers with funds that are subject to Cayman Islands AML regulations can leverage existing services from AML service providers to meet the requirements of the AML Rules, provided any significant differences between the regimes are considered, Smith noted. In most scenarios, the Cayman Islands regime is more stringent, so meeting those requirements should also satisfy the AML Rules, she said.

However, it is worth noting that AML service providers based in the Cayman Islands are only providing services for Cayman funds, Smith continued. An adviser may have non-Cayman funds and operations, so its AML program will need to incorporate facets that do not relate solely to Cayman funds, e.g., employee training. “Although there is some ability to leverage an existing framework, that still has to tie into an adviser’s overall AML policy and business risk assessment that determines how everything fits into their bigger AML picture,” she explained.

The following are some material differences between the AML Rules and the Cayman AML regulations that advisers need to keep in mind.

Scope Activities

The AML Rules apply to all advisers except those with exemptions, while the Cayman Islands regime applies to all persons conducting relevant financial services business and certain non-financial services business, Smith said. Once a private fund or even a Cayman-registered manager is conducting business out of the Cayman Islands, they are subject to that AML regime, she added.

AML Compliance Officer

In addition to the AML compliance officer mandated under the AML Rules, the Cayman Islands regime requires a money laundering reporting officer and a deputy money laundering reporting officer, Smith noted. The Cayman Islands AML regulations allow some overlap between officers, but there must be at least two people in the roles, she highlighted.

See “Walkers Partner Outlines the Steps Cayman Funds Should Take to Comply With the Requirement to Appoint AML Officers” (May 21, 2019).

Policies and Procedures

From a Cayman Islands perspective, there are six or seven main categories to consider when verifying investors’ information, including client identity, geography/location, distribution channel for the particular entity, transaction risk, and the application of any sanctions or lists. Most Cayman Islands AML service providers weigh the various factors – e.g., client risk may have 20% weighting, whereas distribution channel or transaction risk may only have 5% weighting, she elaborated.

Training

Like the U.S., the Cayman Islands regime requires training for staff employees. Cayman AML officers must also complete advanced training, however, which is slightly different from the current wording for the U.S. regime, Smith noted.

Recordkeeping

The recordkeeping requirements in the U.S. and Cayman Islands are similar in that any key documents and transaction records must be retained for at least five years, Smith said. The five-year retention period commences from the date of the last transaction or the last communication about any issues. “Even if you terminated the relationship three years before, you’re still required to keep those documents five years from the date of the last communication – even if that happens after the relationship is terminated,” she elaborated.

Independent Audit

Regular independent audits are required in both the U.S. and Cayman Islands, which may be carried out by an internal audit team, Smith noted. Smaller advisers may not have an independent, in-house audit function and may choose to outsource that work. Again, it is important to ensure appropriate policies and procedures are in place for vendor oversight, bearing in mind the adviser is responsible for any deficiencies, she said.

Other Components

Other components of an AML program – such as customer due diligence, CIP, investment due diligence, governance and oversight – are all largely similar as between the U.S. and Cayman Islands, Smith mentioned. One notable difference is that the AML Rules do not require advisers to implement a CIP, whereas the Cayman regime requires advisers to not only identify the client but the controllers and beneficial owners (i.e., 10% or more ownership), she added.

For coverage of AML developments abroad, see “E.U. Harmonizes AML Regulation, Creates New Authority” (Aug. 22, 2024).

The PE secondaries market is booming, and much of its growth – by nearly one-third in the year ended October 2024 – is driven by sponsor-led secondary vehicles. Those, in turn, are led by continuation vehicles, in which a new fund managed by a GP acquires one or more assets owned by an older vintage fund rather than selling them through traditional exit routes.

LPs have generally shunned continuation vehicles. When presented with the resulting roll/sell election, they often choose the liquidity of the latter. That may be changing, however, as continuation vehicles become more common and familiar. Still, it is not easy for LPs to roll their existing fund investment into a continuation vehicle, as it requires them to navigate information and logistical hurdles.

Those topics were covered in a Morgan Lewis webinar featuring partners John D. Cleaver and Carrie J. Rief. This first article in a two-part series describes the increase in LP interest in rolling into continuation vehicles, the steps involved in the transaction process and factors LPs should weigh when evaluating roll opportunities. The second article will detail issues LPs should diligence when scrutinizing continuation vehicles, as well as the election options available to LPs.

See our two-part series on hybrid M&A single‑asset transactions: “Notable Benefits From Parallel M&A and Continuation Fund Deals” (Nov. 17, 2022); and “Complications to Consider and Negotiating Points to Navigate” (Dec. 1, 2022).

LPs’ Interest in Continuation Vehicles

The rise of the PE secondaries market has added fuel to the growing popularity of continuation vehicles. Nearly $100 billion was raised by secondaries funds during the 12 months ending September 2024, with roughly half for GP‑led transactions. Of those, the overwhelming majority were continuation vehicles: 96 continuation vehicle deals closed in 2024, a 12.9‑percent jump from 2023 and an astonishing 14 percent of all PE exits on the year. The size of individual continuation vehicles also continues to grow, with an increasing number of deals exceeding $1 billion.

Although the overwhelming majority of LPs still decline to participate in continuation vehicles, there is anecdotal evidence that the “mainstreaming” of the continuation vehicle process is making it more attractive to LPs. “Institutional investors are becoming more fluent in these transactions, and more comfortable making a roll decision on a compressed timeline,” Cleaver explained. Investor comfort is likely to continue to accelerate as data demonstrates the merit of continuation vehicles as investments, and LPs’ fear of missing out grows, Rief speculated. “Many LPs are realizing that they may be giving up considerable value by choosing to sell as the default option,” Cleaver added.

There are other investor-side drivers of increasing acceptance of and participation in continuation vehicles. The denominator effect has eased in recent years, making LPs more willing to consider rolling their stakes into continuation vehicles rather than reflexively taking liquidity to reduce their PE exposure. LPs with sector-specific knowledge are also realizing the opportunities presented by continuation vehicles that hold a single asset or a small handful of assets.

Paradoxically, increased LP interest in continuation vehicles could prove a challenge for the continued growth of the market. Fund sponsors often need a large number of LPs to sell their interests in the assets being rolled into a continuation vehicle to meet the demand of the new fund’s lead investor. Those dynamics constitute one of the many potential conflicts of interest that must be navigated through the still-complex process of launching a new continuation vehicle.

See our two-part series on Dechert and Mergermarket’s 2024 PE survey: “Navigating Fundraising and Regulatory Headwinds” (Jan. 25, 2024); and “Parsing the Ongoing Growth of GP‑Led Transactions and Other Sectors” (Feb. 8, 2024).

Overview of the Transaction Process

The inception of a new continuation vehicle is usually invisible to the LPs who will have to choose whether or not to participate going forward. A letter of intent between the fund sponsor and the continuation vehicle’s would-be lead investor is signed. Those two sides then negotiate a term sheet and limited partnership agreement (LPA) for the continuation vehicle. After those documents are in place, the GP offers its rationale for the deal to the existing fund’s LP advisory committee (LPAC) before the rest of the LPs are notified. “It is key to involve the LPAC in the early stages of the process for diligence purposes,” Cleaver explained.

The sponsor then hires an adviser to structure the asset sale, solicit bids and guide the eventual asset transfer, while the LPAC reviews the transaction details and the many potential conflicts of interest resulting therefrom. If the LPAC votes to waive those conflicts, then the GP can proceed with soliciting interest in the continuation vehicle with both existing and prospective LPs, and those parties can begin their respective due diligence efforts. The lead investor gains access to the portfolio companies’ data room and outlook, while LPs receive the confidential information memorandum (CIM). The CIM should include:

• the proposed terms and conditions;
• how the terms and conditions differ from those in the existing fund’s LPA;
• amendments to governing documents;
• an expense allocation framework; and
• subscription documents for new and rolling investors.

The transaction agreement may also be attached as an appendix to the CIM. “A symmetry of information should extend to the LPs and the election process,” Rief added.

Although negotiations between the GP leading the continuation vehicle deal and the lead investor can take months, LPs generally have 30 days or less to decide whether to sell or roll. Given the volume of the CIM disclosures and the potential requirement to make an additional commitment to the continuation vehicle, this “can be difficult in terms of the bandwidth required and obstacles posed by the approval process,” Cleaver explained. This, however, might be changing as the number of LPs willing to entertain a roll election grows. “There is movement in the institutional investor world to push managers to give more time for the election process.”

Evaluating Continuation Vehicles

As LPs are increasingly willing to roll their fund stakes into new continuation vehicles, they are becoming more sophisticated about evaluating the merits of those transactions across a variety of criteria.

GP Rationales

Given the brevity of the election time frame, LPs need to have a process for evaluating new continuation vehicles. Particular attention should be paid to GPs’ stated rationales for their respective transactions. “Continuation vehicle transactions are premised on giving more time and capital to the assets that are the subject of the transaction, and then winding down the selling vehicles as part of the process,” Cleaver offered. “But from the LP side, it is really important to understand which rationales are really driving the deal.”

Generate Liquidity

The most obvious reason a fund sponsor chooses to pursue a continuation vehicle deal is that a fund’s life is nearing its end and there are no traditional exit routes offering an attractive return for a cornerstone investment. “Continuation vehicles are a convenient way to offer liquidity to existing investors,” Cleaver said. “This is especially true when sponsors are fundraising for new funds.” Continuation vehicles not only allow GPs to offer liquidity to existing investors and employees they wish to entice to join a new fund, but also to incentivize participation from new team members who were not around when the asset was originally purchased.

See “How Key PE Fund Terms Are Being Shaped by Current Fundraising Challenges, Liquidity Needs and Distinct Shifts in the Market” (Feb. 9, 2023).

Investment Opportunities

GPs may also be loath to part with a fund’s strongest asset simply because a fund’s lifespan is nearing its end. That may be especially true when significant potential upside would be unlocked by an additional capital infusion. A fund’s LPA may prohibit follow‑on investments, however, and additional capital may not be available from other traditional end-of-fund-life options such as tenders, securitizations and net asset value facilities.

Particular scrutiny of a continuation vehicle’s rationale is necessary “when an existing fund has remaining unfunded capital or is within the first few years of its term,” Cleaver urged. Still, he acknowledged that the “crown jewel” or “trophy” funds driving the huge growth in single-asset continuation vehicles are “sometimes launched early in the lifespan of those assets.”

Sponsor Economics

It is, of course, impossible to ignore the benefits of a continuation vehicle to GPs beyond providing liquidity to LPs, unlocking an asset’s potential upside and the growing popularity of secondary vehicles. Continuation vehicles also allow sponsors to build their brand through syndication arrangements, while accelerating returns and carried interest. Lengthening an investment’s term through a continuation vehicle also increases the amount of time a GP earns carry and fees on that asset.

When reviewing a continuation vehicle transaction, Cleaver warned that LPs should ensure that the proffered rationales outweigh the benefits to a GP’s bottom line. “Hopefully, there are a number of justifiable rationales for the continuation vehicle, and not just the benefits inuring to the sponsor’s economics.”

Potential Conflicts of Interest

Although sponsors have become quite adept at properly managing the conflicts of interest that are inherent in continuation vehicles, LPs must remain vigilant to ensure that all issues are properly considered and addressed. “Continuation vehicles are rife with conflicts for sponsors as there are a lot of competing interests associated with the transactions,” Rief noted. Most notably, the existing fund and new continuation vehicle will be managed by the same GP, and its interests in and duties to each may be at odds.

The SEC has shown particular concern with conflicts of interest presented by continuation vehicles, including a requirement in the since-vacated private fund advisor rules that managers obtain a fairness or valuation opinion from an independent third-party provider. The SEC also noted that it will focus on whether sponsors “adequately mitigate and fairly disclose conflicts of interest” in continuation vehicle deals in its 2025 examination priorities. “Regulators may be concerned about the often binary choice in these deals, and the potential that sponsors are giving investors a choice between what amounts to two bad options,” Cleaver explained.

See “Conflicts of Interest in an Evolving Landscape: Potential Areas of SEC Examination Risk for GP‑Led Secondary Transactions” (Mar. 20, 2025); and “SEC 2025 Examination Priorities Feature Essential Compliance Concerns, Emerging Technologies and Several Notable Omissions” (Dec. 12, 2024).

Another concern is the level of involvement required from sponsors to complete a continuation fund transaction. Despite the relatively long runway a sponsor has in negotiating a continuation vehicle with a lead investor, “it is important to highlight the time and attention drain,” Rief suggested. “With potential obligations to multiple funds – some of which have overlapping investors – during the continuation fund process, it can be complicated and time-consuming for managers.”

There are tools for sponsors to address conflicts, including independent fairness and valuation opinions. Representation and warranty insurance can also be used, “so any claim by the continuation fund against the selling fund would not come out of the pockets of the investors in the selling fund,” Cleaver said. “It would instead come out of the insurance policy so that the GP does not have to seek recourse from one fund it manages against another fund it manages, which of course would highlight the direct conflict.”

Luckily, sponsors are highly motivated to run a process that will yield a fair price, Cleaver continued. “GPs want to ensure they will not be second-guessed later on, and running an auction process serves to take the GP out of the valuation process and somewhat cleanses the inherent conflict.”

See our two-part series “The Evolution and Future of GP‑Led Restructurings”: Transaction Structuring Trends and Conflicts of Interest Management (Jun. 2, 2020); and Key Considerations When Negotiating Fees, Expenses and RWI (Jun. 9, 2020).

Next Time: Negotiating Future LPAs

Many difficulties presented by roll/sell elections stem from the fact that older, existing fund LPAs usually did not contemplate the possibility of a continuation vehicle. “Ten or 15 years ago, LPAs were slimmer and there was less overt language about certain situations,” Rief explained. Today, however, “I am more hesitant than I was in the past to take a document at face value that does not reference continuation funds,” she admitted. “It is good contractually to get out ahead of it and have those discussions. The more processes that can be embedded within the contract, the fewer surprises you are going to see.”

Still, the inclusion of continuation vehicle clauses in LPAs is not always to an LP’s benefit. “We are seeing an uptick in LPAs that automatically permit the use of continuation funds,” Rief noted. “From an investor standpoint, those provisions generally become more balanced during negotiations; I am not seeing a lot of them unmodified from initial drafts.” Instead, investors should seek restrictions on continuation vehicles to the end of an underlying fund’s life, and ensure early LPAC involvement and consent in the process, she suggested.

The proliferation of outsourcing in the investment management space is apparent, with reliance on third parties for everything from IT to chief investment officers and everything in between. This article explores the newfound popularity and acceptance of the outsourced CCO (OCCO), as well as the evolution and catalysts driving this industry trend.

For more insights from Wilke, see “Sanctions 101: Their Impact on Private Fund Investors and Investments (Part Two of Three)” (Sep. 20, 2022).

The OCCO Evolution

Not long ago, the concept of an OCCO for a U.S. registered investment adviser (RIA) was universally frowned upon by regulators, global law firms and institutional allocators alike. For example, in November 2015, the SEC issued a risk alert on OCCOs that highlighted “certain compliance weaknesses associated with registrants that outsourced their CCOs.”

Then there was a reversal in conventional wisdom. Driven by the coronavirus pandemic; advances in technology and remote connectivity; and enhancements in outsourced solutions, acceptance of the OCCO model is at an all-time high and is, in many cases, even preferred over the traditional dual-hatted internal CCO. Driving this trend is a series of factors, including a maturation of the compliance consulting community and a pivotal new pragmatism on the part of regulators and investors regarding the execution of an RIA’s compliance program.

Rule 206(4)‑7 promulgated under the Investment Advisers Act of 1940 (Advisers Act) specifies that an individual designated as a CCO must:

• be competent and knowledgeable regarding the Advisers Act requirements;
• be empowered with full responsibility and authority to develop and enforce appropriate policies and procedures for the RIA; and
• have sufficient seniority and authority within the organization to compel others to adhere to the policies and procedures.

Despite the Dodd-Frank Act’s spanning some 2,300 pages, Congress chose only to include those three vague prerequisites for the individual responsible for an RIA’s compliance program. Surely unintended, the absence of any requirements around licensing, continuing education or industry experience has nevertheless led us to today’s reality, in which outsourcing the CCO title and function has become commonplace.

So, why did it take so long for the investment advisory community to become comfortable outsourcing the CCO role when it has been prevalent for years in adjacent settings, such as mutual fund trusts and broker-dealers? There is no definitive answer but rather a series of contributing factors that led to the resistance:

• high-profile scandals, such as those involving Bernard Madoff, SAC Capital and Galleon, brought about intense scrutiny of the industry, leading most RIAs to build up internal compliance resources to address the wave of new SEC regulations;
• the immaturity of the compliance consulting industry and a general uneasiness around the interpretation and application of new rules and regulations; and
• concerns over CCO and supervisory liability, shared by both external consultants and RIA management.

See “SEC Commissioner Uyeda and Enforcement Director Grewal Discuss Compliance Challenges and CCO Liability” (Jan. 25, 2024); “Updates to the NSCP’s Firm and CCO Liability Framework” (Jun. 29, 2023); and “SEC Action and Commissioner Peirce’s Statement Shed Light on CCO Liability” (Oct. 4, 2022).

A Dimming Industry Spotlight

It has been well over a decade and a half since Madoff’s multi-billion-dollar fraud was unearthed in late 2008, and, although other RIA-related scandals have emerged over the last 17 years, they all pale in comparison to the breadth, complexity and impact of Madoff’s actions. Today’s headlines are largely dominated by enforcement actions involving what many would consider to be victimless technical violations – a key example being employee off-channel communications.

Over the past few years, dozens and dozens of large RIAs, broker-dealers and banking institutions have been fined hundreds of millions of dollars in aggregate for violating books and records retention rules. Generally speaking, those actions do not involve findings – or even allegations – of fraud or investor loss, and, therefore, one can question the appropriateness of such exorbitant monetary penalties in the absence of a traditional “bad actor.” Main Street simply does not care about brokers’ unarchived text messages – in stark contrast to the outrage over the approximately $65‑billion Madoff scheme or the 2008 government bank bailout.

See “SEC Fines 12 Firms $63.1 Million in New Off-Channel Communications Settlements” (Mar. 20, 2025); and “SEC and CFTC Commissioners Call Out Impossible Standards and Ulterior Motives Driving Off‑Channel Communication Enforcement Efforts” (Nov. 14, 2024).

Considering the deregulatory climate and populist sentiment of the new Trump administration, it is reasonable to conclude that scrutiny of the financial services industry will continue to dissipate, assuming, of course, that no major scandals or frauds are exposed in the coming years.

Political ideology aside, regulators and legislators should be applauded for this new normal. Dodd-Frank, while far from perfect, has stymied fraudulent activity. The Custody Rule, despite its numerous shortcomings, has created a multi-faceted system of checks and balances that safeguard assets and foster investor protection. The SEC, whether implementing “broken windows” under Chair Mary Jo White or engaging in feverish rulemaking under Chair Gary Gensler, has proven effective in its regulation of the industry.

Are there still instances of malfeasance within the industry? Of course. It is impossible to stop a bad actor from forging signatures, an unscrupulous private fund manager from faking fund audits or a rogue adviser from taking advantage of his or her elderly clients. Nevertheless, the scale and magnitude of those occurrences are nominal compared to the mass casualty events of decades past.

See this two-part series on a decade of Dodd-Frank: “Why and How the Regulations Brought Private Funds Into Compliance” (Oct. 27, 2020); and “SEC Enforcement, the Volcker Rule and a Report Card on Its Efficacy in Hindsight” (Nov. 3, 2020).

Best Practices and Consensus Building

The regulatory scheme established by the Advisers Act is largely principles-based, meaning that, with limited exceptions, RIA conduct is governed by a series of high-level guidelines, as opposed to a prescriptive rules-based regime.

Given the diversity of the RIA industry, the principles-based framework is appropriate as it affords much-needed flexibility in the application of regulatory requirements. Mutual fund managers, retail robo-advisers, PE sponsors, securitized real estate managers, hedge fund managers, wealth advisers and institutional investment consultants are all RIAs governed by the same set of regulations. A more prescriptive framework would inevitably result in irrelevant redundancies and misplaced administrative obligations.

Despite the subjective nature of RIA regulations, however, the industry is still subject to the “square peg in a round hole” phenomenon. This is especially true regarding the adoption of new rules, the initial application of which is almost universally unclear for both RIAs and regulators alike.

In these situations, how does the uncertainty fade and clarity materialize? The answer is time. It takes time for the SEC to educate itself. It takes time for the industry to develop consensus. It takes time for industry groups’ advocacy to make an impact. It takes time for enforcement actions to run their course and set precedent.

Regulation takes on a lifecycle of its own – from infancy to maturity. Time is measured in years – if not decades – and although the environment remains subject to evolving political winds, we seem to have progressed from a period of trial and error to one of relative stability. We have seen refinements in the overall body of case law; enhanced regulatory interpretations and guidance; and instructive enforcement actions, resulting in greater certainty around the application of the Advisers Act and the regulations thereunder.

Speculation has been displaced by awareness and predictability. Fear over the next unknown enforcement-worthy deficiency has subsided. CCOs, law firms and compliance consultants have a more complete understanding of the regulatory nuances and a better grasp on how to deal with them in a variety of circumstances. This has spawned a marketplace of new solutions. For example, artificial intelligence-based reviews of electronic communications are replacing manual surveillance. Application Programming Interface integrations have automated employee transactional and holdings reporting, eliminating the reliance on paper statements. Fee and expense allocation tools have made forensic testing and policy adherence far more effective and efficient. As a result, compliance execution is more streamlined and less fragmented than ever before, helping to drive both supply and demand of the OCCO.

Growing Comfort With OCCO Risk

With the fading limelight, RIA management’s concerns over compliance program ownership seem to have dissipated, the compliance consulting business has matured exponentially, and the paranoia around liability issues has subsided materially.

The SEC’s historic unease over the concept of an OCCO is readily apparent – from routine examinations in which the staff is privately critical of such arrangements to public speeches by former SEC Chair Gensler and proposed rules aimed at enhanced oversight and due diligence of outsourced providers. Tellingly, however, is the fact that never once has the SEC moved to prohibit the use of OCCOs. Nevertheless, the concern has always been two-fold:

1. the absentee OCCO who lacks the commitment, aptitude and authority to execute an RIA’s compliance program; and
2. an RIA’s “outsource it and forget it” mentality when it comes to compliance adoption.

First-hand experience now tells us that the SEC is comfortable with the concept of the OCCO so long as he or she is rightfully empowered; possesses institutional knowledge and regulatory acumen; and devotes sufficient time and energy to the RIA.

As the SEC has warmed to the idea of the OCCO, so too have the RIA and regulatory consulting communities. The reputational risk and stigma associated with an SEC investigation or enforcement action are among the biggest threats to an RIA’s business. Negative headlines are a surefire way to undermine capital-raising activities, and, historically, few management teams were willing to buck the insourcing trend in favor of an OCCO. There have always been individuals willing to take on the CCO role as independent contractors; however, this market was highly fragmented and dominated by solo practitioners, while larger, established consultancies shied away from the title and liability. Anecdotes of horror stories involving inadequate and inept OCCOs exposed during SEC examinations spread through the industry like wildfire. These tales – likely exaggerated and overblown – drove a deep-seeded reluctance for most large consulting firms to enter the market until the perfect storm of contributors emerged.

See “The SEC’s Recent Revisions to Form ADV and the Recordkeeping Rule: What Investment Advisers Need to Know About Managed Account Disclosure, Umbrella Registration and Outsourced CCOs (Part One of Two)” (Nov. 3, 2016).

In the late 2010s and early 2020s, we saw massive consolidation in the fund services space – specifically compliance consulting – as PE flooded the sector. With the arrival of so-called “smart money” on the scene came an institutionalization of service and product offerings, notably around OCCO staffing, oversight and governance. Innovation drives the financial industry, and compliance consultants are no different.

Sensing a shift in attitude, U.S. consultancies sought to capitalize on opportunities and pioneered innovative new staffing models to capture OCCO market share. The coronavirus pandemic was also a key contributor to this evolution. The five-day in-office work week disappeared (at least for several years), replaced by virtual meetings, file sharing applications and remote working environments. The work-from-anywhere model, although not without its critics, proved practicable, and, even though on-site time has made a comeback, the industry now recognizes that a CCO need not be perched above a trading desk to effectively administer a compliance program.

Innovation in technology and outsourcing solutions have reduced the time and resource commitment necessary to satisfy a CCO’s duties. For example, CCOs are no longer combing through paper account statements and manually reconciling holdings and transactional data to satisfy their code of ethics requirements. The need for CCOs to conduct manual pre-trade compliance checks for concentration limits or locates has been replaced with automated compliance modules with order and execution management systems. Technology solutions around side letter compliance management have displaced the need for time-intensive CCO audits.

From the perspective of compliance consultancies, this innovation has driven the acceptance of the OCCO title for two reasons:

1. Given the increased efficiencies, the CCO function does not always require full-time resource commitment, which makes staffing more efficient and cost effective.
2. The adequacy of the tools available to CCOs reduces redundancy and decreases the instances of mistakes, leading to more effective compliance execution.

Institutional consultants and allocators tend to be the most scrutinizing faction in the fund ecosphere, yet they were among the earliest proponents of outsourcing, provided it was resourced properly. Operational due diligence (ODD) can be an incredibly intrusive look under an RIA’s hood, exposing weakness, deficiencies or vulnerabilities that may not be uncovered by even the most probing SEC examination. For most middle market fund managers, ODD inquiries are handled by a combination of investor relations professionals, CFOs, COOs and/or CCOs, the latter often being a secondary title for a dual-hatted officer. It is conceivable that allocators’ early adoption of outsourcing the CCO position was driven, at least in part, by interactions with dual-hatted CCOs with insufficient compliance experience. A lack of regulatory competency can be easily discerned through a series of simple compliance questions. If the answer is consistently, “We outsourced that,” then why not outsource the role in its entirety?

See this three-part series on on-site ODD: “Benefits of In‑Person Diligence and Preliminary Steps for Investors to Take” (Oct. 8, 2019); “Tips for Ensuring an Efficient Visit and Meeting With Critical Manager Personnel” (Oct. 15, 2019); and “Post‑Visit Steps to Memorialize and Follow Up on Diligence Results” (Oct. 22, 2019).

Allocators find a way to be both scrupulous and reasonable at the same time. Proper risk mitigation is priority number one and requires more than a check-the-box due diligence questionnaire or superficial interviews of management. The investor community understood relatively early on that an individual whose name is on the Form ADV and who is part of an established consultancy with internal controls presents less risk than an internal staffer with limited experience and little to no oversight. Larger consultancies will generally manage their own risk by performing quality control checks and governance of OCCO engagements. Moreover, developed organizations with a deeper and more diverse client base can harness experiential data points to empower their consultants and OCCOs. This institutional backstop lends credibility to the outsourcing process and fuels the ever-growing acceptance of the OCCO. The fundamental perception has changed: the risk no longer outweighs the benefit.

Here to Stay or Gone Tomorrow?

For all the reasons stated above, the OCCO trend seems to be on the ascent portion of the hockey stick curve. OCCO supply and demand are growing lockstep, as RIAs look for staffing alternatives and compliance consultancies come up with new solutions.

In addition, the concept of outsourcing and the interplay of risk among various entities is not a new dynamic in non-U.S. settings, such as alternative investment fund managers in the E.U. or third-party fund governance in the Cayman Islands. And, although the RIA community may be behind the global curve in terms of adoption, the OCCO trend is gaining momentum, and the arrangement is likely to explode in popularity under new SEC stewardship.

 

Sean R. Wilke is senior managing director and head of growth strategy at IQ‑EQ. He joined the firm by virtue of its acquisition of Greyline, a regulatory consulting firm in which he was an early-stage partner and head of growth. In addition to managing commercial affairs, he specializes in advising fund managers on various matters regarding regulatory issues, business operations, structuring and organizational administration. Before entering the consulting industry, Wilke also served as the GC and CCO of a multi-billion-dollar credit manager, a senior associate in the investment management group of a law firm and a compliance associate in the investment banking division at Bear Stearns.

Steve Y. Yoo has joined Paul Weiss as a partner and head of the firm’s Los Angeles investment funds group. He focuses on the structuring, formation and operation of PE funds, as well as continuation funds and GP‑led secondary transactions.

See “Continuation Vehicles Survey Highlights Increasing Convergence of Some Terms, Vicissitudes Among Others” (May 29, 2025); and “Unique Features of GP‑Led Private Credit Secondaries Funds” (May 15, 2025).

In addition to the structuring, formation and operation of private funds and their management companies, Yoo counsels fund managers on all facets of their business, including regulatory compliance; internal economic and governance matters; GP‑stake sale transactions; restructurings; compensation and employment arrangements; and succession planning. He also advises on the formation of continuation vehicles, including single-asset and multi-asset GP‑led secondary transactions.

Yoo arrives from Kirkland & Ellis, where he was a partner.

For insights from Paul Weiss, see “U.K. Regulators Propose Changes to AIFM Rules to Ease Compliance Burden on Fund Managers” (May 29, 2025); and “Inherent Obstacles and Promising Pathways to Retailization in the PE Industry” (May 29, 2025).