Alternative Investment

SOC Reports Explained: A Guide for Fund Service Providers

The alternative investments industry faces an ever-growing list of compliance requirements and security challenges. System and Organizational Controls (SOC) reports have emerged as a critical tool for demonstrating a service organization’s commitment to implementing and maintaining robust internal controls and data security.  By completing an annual SOC engagement, companies proactively address organizational risks and drive trust and transparency with customers, prospects, and stakeholders. As a service organization, SOC reports are becoming more common, and if you haven’t been asked for one yet, that time is not far away.  

What are SOC Reports? 

System and Organization Controls, or SOC reports, are independent audits of a service organization’s internal controls. SOC audits are conducted to verify the effectiveness of a service organization’s internal controls and for handling customer data securely. There are a few different types of SOC reports based on your organization’s needs: 

SOC 1 is relevant for companies performing financial transaction processing or supporting transaction processing systems. This report focuses on any outsourced services that could impact a company’s financial reporting. This could include NAV calculation, investor reporting, trade processing, general ledger systems, pricing, valuation, or data and payment processing systems. SOC 1 reports are intended for use by fund managers and their independent auditors. 

SOC 2 is most commonly needed and is essential for any service provider that handles sensitive fund data or supplies and supports critical IT systems. A SOC 2 evaluates internal controls based on the 5 trust services criteria, security, availability, confidentiality, privacy and processing integrity.. Engaging with an independent auditor to conduct an annual SOC 2, fund service providers demonstrate their commitment to protecting investor data and fund information.  

Types Within Types: Understanding SOC Report Classifications 

Each SOC report also includes a type, such as “SOC 1 Type 2” or “SOC 2 Type 1.” SOC reports are divided into two types: Type 1 reports provide a snapshot of the service organization’s controls at a point in time, and Type 2 reports provide a more in-depth assessment of the service organization’s controls over a period of time. 

• Type 1: Examines control design at a specific point in time. These are most often used for baseline assessments, significant changes to the design of new controls, or quick-turn customer requests. They can be completed more quickly than a Type 2 and can be used to identify any gaps or issues in the interim.  

• Type 2: Assesses control design and operating effectiveness over a defined period. These are used for ongoing compliance and assurance needs, such as when clients or regulators require evidence that the controls are well-designed and effectively working as intended. Type 2 provides a higher level of assurance and is generally preferred for ongoing compliance needs. 

Choosing the Right SOC Report 

With various types of SOC reports available, knowing which ones apply to your organization can be daunting. As a fund service provider, you most likely need a SOC 2 report. If you provide outsourced services that could impact your clients’ financial reporting, such as fund administration or valuation services, then you also need a SOC 1. The type of report you choose will depend on your objective. Since fund administration services directly affect funds’ financial statements, a SOC 1 report is typically the best fit. For legal service providers dealing with highly sensitive information, a SOC 2 report is likely a better fit. Work with a qualified provider to determine the right type of report based on your organization to effectively and efficiently meet compliance requirements and mitigate risk.  

However, SOC reports are only one part of an effective security posture. Your organization should also conduct annual risk assessments, IT internal audits, vulnerability testing, and comprehensive risk management strategies which are key to maintain a robust security program.  

The Competitive Advantage 

SOC reports will become increasingly important in the alternative investments industry and demonstrating your commitment to data security and robust internal controls is essential. By embracing SOC reports and a comprehensive security approach, you’re not just checking a compliance box – you’re building a foundation of trust that will set your business apart in an increasingly security-conscious market.  

SOC examinations can be complex, but their importance cannot be overstated. If you’re feeling overwhelmed, seek expert guidance from Richey May’s experts. We understand the unique challenges of the alternative investments industry. Our expertise allows us to provide tailored insights into System and Organizational Controls (SOC) reports, which are crucial for compliance and risk management in today’s competitive landscape. Contact Steve Vlasak today for more information.