SEC Scrutinizes Private Equity Continuation Funds Over Conflict of Interest Concerns

WASHINGTON — The U.S. Securities and Exchange Commission has launched a review into the booming market for private equity continuation funds, focusing on potential conflicts of interest and the adequacy of disclosures provided to investors, according to reports that surfaced in late 2023.

The inquiry centers on transactions where a private equity firm, or general partner (GP), sells a successful company from an older fund to a new, specially created vehicle—the continuation fund—which the same firm also manages. This practice allows the GP to retain control of a prized asset beyond a typical fund's lifespan while offering a liquidity option to the original fund's investors, known as limited partners (LPs). The SEC is examining whether the disclosures in these complex deals are sufficient and if the process for valuing the assets is fair to all parties involved.

This SEC review highlights a critical tension point in the private markets that directly impacts mid-sized businesses. For a company held by a private equity fund, being transferred to a continuation fund can feel like a positive development, signaling the sponsor's continued belief in its growth. However, the inherent conflict of interest—where the GP is both the buyer and the seller—can lead to valuations that favor the new fund over the selling investors. We have seen situations where the terms of these deals are opaque, leaving business owners and management teams with uncertainty about their new ownership structure and long-term incentives. This regulatory scrutiny is a necessary step toward greater transparency. For business owners navigating a potential sale or partnership with private equity, understanding the nuances of these structures is paramount. This is a core component of the capital raising and investor strategy services provided by C&S Finance Group LLC at csfinancegroup.com, where we help clients dissect complex deal terms to ensure their interests are protected.

The market for these so-called GP-led secondary transactions has exploded in recent years, transforming from a niche strategy into a mainstream feature of the private equity landscape. Industry data shows that transaction volume for continuation funds has surged, reaching tens of billions of dollars annually as firms seek ways to hold onto their top-performing assets in a volatile exit environment. This rapid growth has inevitably attracted regulatory attention.

The primary conflict the SEC is investigating arises from the valuation process. The GP has an incentive to set a lower purchase price for the asset being moved into the continuation fund. A lower entry price benefits the new fund's investors—and the GP's own future performance fees, or carried interest—but comes at the direct expense of the LPs in the original fund who are cashing out. The review is expected to probe how firms establish these valuations, whether they obtain truly independent fairness opinions, and how clearly they communicate the entire process to LPs.

Investors in the original fund are typically given the choice to either sell their stake at the determined price or roll their investment into the new continuation vehicle. The SEC's focus on disclosure adequacy is meant to ensure these LPs have enough clear, unbiased information to make a well-informed decision. This includes understanding the fees associated with the new fund and any differences in terms compared to the original fund.

This regulatory sweep is consistent with the SEC's broader focus on the private fund industry under Chair Gary Gensler. In August 2023, the commission adopted new rules for private fund advisers that directly address adviser-led secondary transactions. The rules mandate that advisers obtain a fairness opinion or a valuation opinion from an independent provider for all such transactions and distribute it to investors. The current review can be seen as an early examination of industry compliance with these new standards and a signal that enforcement will be a priority.

The inquiry is likely being conducted by the SEC's Division of Examinations, which periodically sends sweep letters to a range of firms to gather information on industry practices. The results of such reviews can lead to deficiency letters for individual firms, public risk alerts outlining best practices for the entire industry, or, in more serious cases, referrals to the Division of Enforcement for potential violations of securities laws.

For the private equity firms managing these funds, the SEC's review will likely increase compliance costs and administrative burdens. They may need to overhaul their internal processes for valuations and investor communications to withstand heightened scrutiny. For the mid-sized businesses that are the underlying assets in these funds, the practical impact could be longer transaction timelines and more rigorous due diligence as their private equity owners work to build a defensible, well-documented case for the transfer.

Industry participants will be closely watching for any public statements, risk alerts, or enforcement actions that emerge from the SEC's review. The findings could establish new precedents for transparency and fairness in the continuation fund market, potentially reshaping how private equity firms manage their portfolio companies at the end of a fund's life.