Mon, Jun 29, 2020

Observations from Examinations of Investment Advisers Managing Private Funds

On June 23, 2020, the Security and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) published a risk alert regarding certain compliance issues observed in examinations of registered investment advisers that manage private equity funds or hedge funds (collectively, “private fund advisers”). The deficiencies observed by staff were related to Sections 206 and 204A of the Investment Advisers Act of 1940. This risk alert was issued to encourage private fund advisers to review their practices, policies and procedures related to implementation, conflicts of interest, fees and expenses, as well as policies and procedures for material non-public information (MNPI) discussed below. 

Conflicts of Interest 

OCIE staff observed that private fund advisers failed to adequately disclose a number of conflicts of interest including conflicts related to the following: 

  • Allocations of investments 
  • Multiple clients investing in the same portfolio company
  • Financial relationships between investors or clients and the adviser
  • Preferential liquidity rights
  • Private fund adviser interests in recommended investments
  • Coinvestments
  • Service providers
  • Fund restructurings
  • Cross transactions


Fees and Expenses

In addition, OCIE staff observed deficiencies involving fee and expenses, including the following:

  • Misallocation of fees and expenses
  • Inadequate disclosure related to the costs associated with operating partners
  • Inconsistent valuations causing incorrect management fees and carried interest
  • Mishandling of receipt of fees from portfolio companies (e.g. monitoring fees, board fees or deal fees)


MNPI/Code of Ethics

OCIE staff observed instances in which private fund advisers did not adequately address risks posed by employees, including the following:

  • Employees interacting with individuals that had access to MNPI (e.g., insiders of publicly traded companies, expert network consultants and value-added investors)
  • Employees ability to access MNPI through office space or systems of the adviser or its affiliates that possessed MNPI
  • Employees who periodically had access to MNPI about issuers of public securities (e.g., in connection with private investment in public equity)

OCIE staff also observed deficiencies related to private fund advisers’ enforcement of code of ethics provisions related to the following:

  • Trading of restricted securities
  • Failing to enforce policies and procedures pertaining to gifts and entertainment from third parties
  • Submission of quarterly transaction reports and holdings reports on a timely basis
  • Lack of preclearance required

The private fund adviser issues identified above resulted in a range of actions, including no comment letters, deficiency letters and, where appropriate, referrals to the Division of Enforcement.

For further information and examples related to the private fund advisers compliance issues identified, you can find the entire report here.

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