Why operational due diligence now decides allocations

Allocator selection used to run in one direction: performance opened the conversation, and the operational review was a closing formality. That order has inverted, and the inversion is the most consequential of the operational due diligence trends now shaping how capital moves. It was not a change of mood. Between early 2022 and late 2025, the federal rulebook for U.S. private fund advisers shrank, the SEC reorganized its examination program around operations, and two enforcement actions demonstrated that the classic ODD checklist could be defeated from the inside. Each development pushed allocators toward the same conclusion: if operational integrity is going to be verified at all, the diligence process is where it happens.

The federal rulebook shrank, and diligence absorbed the load

On June 5, 2024, the Fifth Circuit vacated the SEC’s Private Fund Advisers rules in their entirety, holding that the Commission had exceeded its authority under the Advisers Act. The vacated package included two provisions allocators had been counting on as a floor: a mandatory annual audit for every advised private fund, and standardized quarterly statements covering fees, expenses, and performance.

The practical effect was not deregulation in the abstract. It was a transfer of burden. Audited financials and standardized fee reporting are no longer federal minimums; they exist where investors negotiate them — in governing documents, in side letters, and in the diligence that decides whether capital moves at all. The vacatur reaches only the federal overlay for U.S. advisers; Cayman obligations, fiduciary duties, and contractual undertakings stand. But the diligence consequence follows directly: protections that were once assumed now have to be asked for, evidenced, and contracted. When the regulatory floor disappears, the allocator’s process becomes the floor.

The regulator reframed its own work around operations

The SEC’s examination priorities for fiscal 2026, announced in November 2025, dropped the standalone private funds section for the first time since 2021 and folded private fund advisers into the Division of Examinations’ general categories — a change commentators read as private fund oversight going mainstream. The substance supports that reading. The Division flagged advisers to newly launched private funds and first-time private fund advisers for review of “regulatory awareness, liquidity, valuation, fees, disclosures, and differential treatment of investors, including use of side letters.” It flagged allocation favoritism where advisers also run separate accounts, and merged advisory practices creating operational and compliance complexities. The compliance core it listed — “marketing, valuation, trading, portfolio management, disclosure and filings, and custody” — is, nearly line for line, the table of contents of an institutional ODD questionnaire. The document even describes the Division’s own internal operational effectiveness framework.

The signal for managers is direct: what an examiner will ask in year two, an allocator asks before close. The two reviews have converged on the same subject matter, and the allocator’s version comes first.

Offshore, governance became an examinable standard

The same convergence happened in Cayman, earlier. CIMA’s Statement of Guidance on corporate governance for mutual funds and private funds, issued in April 2023 and in force since late that year, made fund governance an examinable standard rather than a best practice. Operators — boards, general partners, trustees — are expected to regularly assess the suitability and capability of their service providers and satisfy themselves that those providers are monitoring compliance; to maintain a written conflicts-of-interest policy, with conflicts disclosed at least annually; to convene at least once a year, more where size or risk requires; and to approve audited financials while monitoring whether NAV is actually being calculated in accordance with the fund’s valuation policy.

Allocator questionnaires now track that standard almost item for item: provider oversight, NAV policy monitoring, conflicts logs, minuted meetings. For a Cayman-registered fund, those asks stopped being bespoke institutional preferences and became the regulatory baseline — which means a manager who cannot evidence them is failing two reviews at once.

The checklist failed in public

Two enforcement actions explain why allocators stopped accepting the presence of service providers as proof of anything. In September 2025, the SEC filed fraud charges over the Prophecy Asset Management fund complex, which raised more than $500 million between 2014 and 2020. Investors were told capital was spread across dozens of sub-advisers, each posting cash collateral against losses. In reality, most of it went to a single sub-adviser whose losses far exceeded his collateral — and, per the SEC, the firm and its executives worked with him to “deceive the funds’ auditor and administrator – and, in turn, investors – through fabricated documents” and a series of sham transactions. Redemptions were suspended in March 2020 after losses exceeded $350 million.

In February 2022, the SEC charged Infinity Q’s founder with overvaluing the assets of a mutual fund and a private fund over a multi-year period by “altering inputs and manipulating the code of a third-party pricing service” — subverting the very control that existed to keep valuation independent — while collecting more than $26 million in profit distributions.

Both operations carried the checklist items: auditor, administrator, third-party pricing. The fraud ran through or around them. The methodological consequence inside allocator teams was a shift from verification to tracing — confirming cash and holdings directly with the administrator rather than through the manager, testing who controls pricing inputs rather than whether a pricing feed exists, mapping who can actually move money rather than reading the controls memo.

Operations is now the underwriting variable

The economics of the review reinforce the structural changes. An ODD rejection is close to permanent: in a 2014 Deutsche Bank survey reported in industry coverage, 65 percent of investors said they would not consider a fund they had previously vetoed on operational grounds. A 2019 JP Morgan investor survey, cited in industry analyses, found a third of investors had avoided or declined managers that failed operational review. And roughly 70 percent of ODD effort is document preparation and review before anyone arrives onsite — meaning the decision is substantially formed from the manager’s own paper, before a meeting occurs.

For managers, the conclusion is uncomfortable but actionable. Operational readiness is no longer compliance overhead; it is the underwriting variable, examined first, in writing, against standards a manager can read in advance — the vacated protections LPs now contract for, the SEC’s stated exam themes, the CIMA governance guidance. Performance still matters; it determines who gets the meeting. Operations determines who gets the allocation — and unlike performance, every element of it is within the manager’s control before the first allocator call.

SetOne Labs pressure-tests operational readiness against the standards allocators now apply — providers, controls, governance, and the documents that evidence them. To discuss a readiness review in confidence, begin a conversation.

SetOne Labs provides advisory services and general information. Nothing here is legal, tax, or investment advice.