RIA Surprise Examinations: Who Benefits and How to Prepare

For registered investment advisers (RIAs), complying with the SEC’s custody rule involves more than knowing the rules or understanding the exam process. The decision becomes how to meet the requirement through the use of the audit exception or a surprise examination.

Advisers can make confident compliance decisions that protect investors without unnecessary cost or administrative burden by weighing the differences between audits and surprise exams, evaluating fund suitability and taking practical preparation steps.

Differences Between a Surprise Examination and a Financial Statement Audit

When deciding whether a surprise examination or a financial statement audit is right for a fund or special purpose vehicle (SPV), it’s important to understand how each engagement differs in scope, purpose and cost.

Scope and purpose

A financial statement audit is comprehensive. Investors receive a full set of audited financials, including balance sheets, income statements, investment schedules, fair value measurements and related disclosures. Audits assess the accuracy of financial information which provides insight into investment performance, returns and ratios.

In contrast, a surprise examination is narrowly focused. The accountant evaluates management’s assertion that the fund is in compliance with specific provisions of the Investment Advisers Act of 1940, primarily the custody rule. The objective is investor protection and fraud deterrence, not performance evaluation or fair value reporting. Investors do not receive information on fund performance or valuation but do gain some comfort on the existence of the investments.

Timing and reporting differences

Surprise examinations are unpredictable by design. The examination date is selected by the accountant without prior notice, and the results are documented in an independent accountant’s report and a management statement regarding compliance. This report is filed with the SEC via Form ADV-E and is publicly accessible but not distributed directly to investors.

Financial statement audits, on the other hand, are scheduled and planned in advance, with reports typically shared directly with investors.

Coverage and efficiency

One advantage of a surprise examination is efficiency, particularly for advisers managing multiple entities. A single surprise exam can cover multiple funds or SPVs, reducing duplication and cost. In a financial statement audit, each entity generally requires its own audit, increasing administrative burden and fees.

For example, auditing 15 SPVs individually could cost roughly $225,000, assuming $15,000 per audit. A surprise examination covering all 15 entities might range from $10,000 to $30,000 in total, offering substantial cost savings without sacrificing regulatory compliance.

What RIAs should consider:

• Focus: Custody exams target compliance at the advisor level. Audits focus on financials at the entity level.
• Investor information: Audits provide assurance over financial statements. Surprise exams provide limited information to clients but satisfy compliance requirements.
• Cost: Surprise exams are generally less expensive, especially as the number of entities increases.
• Fraud prevention: Both help ensure proper handling of client assets — a surprise exam verifies asset existence unexpectedly, while an audit assesses accuracy of the financial statements.

Who Should Choose a Surprise Examination?

Not every fund is a good fit for a surprise examination. Institutional investors often expect audited financial statements with investments recorded at fair value, and many partnership agreements or side letters require an annual audit from the outset. In other cases, advisers may find that a surprise examination is not only acceptable but also a more practical and cost-efficient option.

Surprise examinations work well when:

• Multiple SPVs are involved: A single exam can cover them all, avoiding the cost of separate audits for each entity.
• No audit requirement exists: The governing documents do not mandate audited financial statements.
• Assets under management are limited: The higher cost of a financial statement audit may not be economically viable.
• Valuation is difficult or impractical: The fund holds assets that are inherently hard to value, or management lacks the resources to establish fair value.

A hybrid approach: Achieving cost-effective compliance

It’s common for advisers to use a combination of financial statement audits and surprise examinations. This hybrid approach can offer both flexibility and cost savings.

Illustrative example

Consider an RIA that historically launched several small SPVs with no audit obligations. Later, after establishing a larger fund that crosses the assets under management (AUM) threshold for SEC registration, the custody rule applies to all funds under their management, including legacy SPVs.

In this scenario:

• The new, larger fund’s institutional investors may request a financial statement audit, either contractually or as a condition of investing.
• The legacy SPVs’ investors have not historically received financial statements and do not require them.

A more workable option in this scenario is to engage an independent public accountant to conduct a surprise examination on the legacy SPVs while performing a full audit for the new fund. This approach satisfies custody rule requirements across all entities and keeps compliance both feasible and cost-effective.

The Critical Role of the Qualified Custodian

Under Rule 206(4)-2 of the Advisers Act, investment advisers must engage a qualified custodian to deliver account statements to investors at least quarterly unless they rely on the audit exception. While that requirement seems straightforward, not all custodians provide the same level of service. Understanding these differences is critical to making the right choice.

Minimal involvement: Some custodians focus on the minimum necessary for regulatory compliance.

• Their role is limited to safekeeping key documents such as partnership agreements and subscription documents.
• They issue quarterly statements that may only list the name of the investment.
• The custodian relies on the adviser to notify them of changes, with no direct interaction with the underlying issuer.

Robust solutions: Other custodians take a more active role in day-to-day monitoring.

• They engage directly with the issuer, creating a safeguard so advisers cannot initiate transactions unilaterally.
• Their investor statements often include additional details such as cost basis, purchase dates and a summary of transactions.

In more comprehensive setups, the custodian may also handle new investment processing, ongoing account operations, payments and coordination with the fund or SPV’s administrator.

Choosing the right qualified custodian with the appropriate level of involvement can reduce operational risk, streamline daily activities and provide investors with clearer, more reliable reporting.

How to Prepare for a Surprise Examination

Preparation is the key to making a custody examination run smoothly. Getting exam ready involves establishing the right partnerships and maintaining impeccable internal records.

Engage your partners early: The process starts with engaging both an independent accountant and a qualified custodian experienced in private fund custody. Ideally, these parties are engaged at the same time to maintain alignment on the information presented in custodial statements and the expectations for the examination process.

Maintain strong books and records: The effectiveness of any examination relies heavily on the quality and accessibility of your firm’s books and records. Many funds engage third-party administrators (TPAs) to manage accounting and investor reporting. Working with a reputable TPA helps ensure the general ledger is accurate and that critical documents, such as partnership agreements, subscription agreements, transaction support and bank statements, are properly maintained.

If a fund does not use a TPA, it should maintain its own accounting ledger for each entity. Every transaction must be properly reflected in the records, with supporting documentation for all transactions, including expense invoices and management fee calculations.

Understand the request list: Following the examination date, the independent accountant will issue a preliminary request list, also known as a provided by client or PBC list. Having these items ready ahead of time minimizes delays during the fieldwork.

This list usually includes:

• A list of entities subject to examination
• General ledger (GL) detail for the exam period for each entity
• Trial balance as of the exam date for each entity
• Detail of investor-level capital activity during the exam period, if not already included in the GL detail
• Partnership agreements and amendments for entities in scope

The adviser should also be ready to provide bank statements for any entities under review. During fieldwork, the accountant may request additional documentation and will typically select certain investments and investor capital activity for confirmation. Other transactions may also be tested, requiring advisers to provide timely, well-organized support.

Key Takeaways

Surprise examinations are often overlooked but can be a practical alternative to financial statement audits, particularly for RIAs managing multiple smaller SPVs. While financial audits remain the standard in many cases, they are not always necessary or cost effective.

A well-planned surprise examination can reduce administrative burden, satisfy custody rule requirements and provide meaningful investor protection. With the right custodian, accurate records and strong preparation, RIAs can achieve compliance in a way that balances regulatory assurance with operational efficiency.

Navigating the custody rule can be complex. Contact us. Weaver can help determine if a surprise examination is the right choice for your funds.

©2025

RIA Surprise Examinations Series

This article is part of a series designed for RIAs who manage pooled investment vehicles, such as private funds or SPVs, and need to comply with the SEC’s custody rule. From compliance officers and fund managers to CFOs and operations leaders, this series provides RIAs with practical guidance on surprise examinations, helping them protect investors, meet regulatory expectations and choose the most efficient compliance path.

• RIA Surprise Examinations: What RIAs Need to Know
• RIA Surprise Examinations: What to Expect During the Exams