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OCIE Risk Alert - Investment Advisers Managing Private Funds

June 24th | 2020



The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) published a risk alert concerning compliance issues observed in examinations of registered investment advisers that manage private equity funds or hedge funds, which make up a large part of all advisers the SEC regulates. The Risk Alert discusses three general areas of deficiencies: (1) conflicts of interest, (2) fees and expenses, and (3) policies and procedures relating to material non-public information (“MNPI”).


(1) Conflicts of Interest


This risk alerts spends the most time discussing inadequately disclosed conflicts of interest. An investment adviser must eliminate or make full and fair disclosure of all conflicts of interest which might incline an investment adviser – consciously or unconsciously – to render advice which is not disinterested such that a client can provide informed consent to the conflict. Full and fair means sufficiently specific so that a client is able to understand the material fact or conflict of interest and make an informed decision whether to provide consent. The alert gives some detailed examples of where private fund advisers have not provide adequate disclosure about conflicts relating to:

  • Conflicts related to allocations of investments, particularly among the private funds’ clients based on, for example, their size or fee potential.

  • Conflicts related to multiple clients investing in the same portfolio company, or at differing levels of a capital structure (e.g., different clients owning debt and equity of the same company).

  • Conflicts related to preferential liquidity rights, particularly side letters whose terms may potentially harm other investors.

  • Conflicts related to private fund adviser interests in recommended investments.

  • Conflicts related to coinvestments, particularly misleading disclosure regarding how coinvestment terms operate or not following the disclosed terms at all.

  • Conflicts related to service providers, such as where a private fund does business with entities controlled by the adviser, its affiliates, or family members.

  • Conflicts related to fund restructurings, such as inadequate disclosure of the value of fund interests in a restructuring.

  • Conflicts related to cross-transactions, such inadequately disclosed conflicts related to purchases and sales between clients.

(2) Fees and Expenses

OCIE also observed several fee and expense issues that appear to be deficiencies under Section 206 or Rule 206(4)-8:

  • Allocation of fees and expenses, such as where Advisers allocated shared expenses (e.g.,broken-deal, due diligence, annual meeting, consultants, and insurance costs) in a manner that was inconsistent with disclosures to investors or policies and procedures, thereby causing certain investors to overpay expenses.

  • Misleading investors about who would bear the costs associated with operating partners (i.e., non-employee service providers), thereby potentially causing investors to overpay expenses.

  • Advisers not valuing client assets in accordance with their valuation processes or in accordance with disclosures to clients.

  • Advisers failed to apply or calculate management fee offsets in accordance with disclosures and therefore caused investors to overpay management fees.

(3) MNPI / Code of Ethics

Section 204A of the Advisers Act (“Section 204A”) requires investment advisers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of MNPI by the adviser or any of its associated persons. Advisers Act Rule 204A-1 (“Code of Ethics Rule”) requires a registered investment adviser to adopt and maintain a code of ethics, which must set forth standards of conduct expected of advisory personnel and address conflicts that arise from personal trading by advisory personnel. In this area, OCIE observed, among other things:

  • Advisers did not address risks posed by their employees interacting with: (1) insiders of publicly-traded companies, (2) outside consultants arranged by “expert network” firms, or (3) corporate executives or financial professional investors that have information about investments.

  • Advisers did not enforce trading restrictions on securities that had been placed on the adviser’s “restricted list.”

  • Advisers failed to require access persons to submit transactions and holdings reports timely or to submit certain personal securities transactions for preclearance as required.

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