The Division of Examinations of the U.S. Securities and Exchange Commission recently released a Risk Alert to provide an overview of compliance issues observed in examinations of registered investment advisers that manage private funds. The alert covered areas including conflicts of interest when actions are inconsistent with disclosures and noted the importance of policies and procedures.
According to subject matter experts at Sanne, the Risk Alert provides insight into SEC examination priorities and should be considered in connection with a private fund adviser’s review of their compliance program and disclosures to investors.
Daryoush Niknejad, Sanne’s General Counsel, North America and Michael Barakat, Assistant Director at Sanne, summarized the Risk Alert and highlighted four key areas that private fund advisers should consider in reviewing their compliance program and disclosures to investors. Read on for their insight below.
Failure to act consistently with disclosures
The Risk Alert discusses six areas of conduct observed in examinations that were inconsistent with disclosures to investors.
- Failure to obtain informed consent from Limited Partner Advisory Committees, Advisory Boards, or Advisory Committees (“LPACS”) required under fund disclosures. In addition, staff observed private fund advisers’ failure to bring conflicts to their LPAC for review and consent.
- Failure to follow practices described in fund disclosures regarding the calculation of post-commitment period fund-level management fees. The Risk Alert highlights that failures have resulted in investors paying more in management fees than they were otherwise required to pay.
- Failure to comply with LPA liquidation and fund extension terms.
- Failure to invest in accordance with fund disclosures regarding investment strategy.
- Failure relating to recycling practices. These failures may have caused private fund advisers to collect excess management fees in some instances
- Failure to follow fund disclosures regarding adviser personnel.
Use of misleading disclosures regarding performance and marketing
The Risk Alert describes four general areas of conduct observed in examinations that relate to disclosures regarding performance and marketing, noting that many such areas of conduct appear to be violations of Advisers Act Rule 206(4)-8 and Advisers Act Rule 204-2(a)(16).
- Misleading material information about a track record. Examples of misleading disclosures include cherry picking, not disclosing material information about the impact of leverage on performance and failing to reflect fees and expenses accurately.
- Inaccurate performance calculations, for example data from incorrect time periods and projected rather than actual performance, when creating track records.
- Portability, or the failure to support adequately or omissions of material information about predecessor performance. Examples include failure to maintain books and records supporting predecessor performance and omission of material facts. Watch MCO’s on-demand webinar about
- Misleading statements regarding awards or other claims, including regarding awards they received, and failing to disclose the criteria for obtaining them, the amount of any fee paid by the adviser to receive them, and any amounts paid to the grantor of the awards for the adviser’s right to promote its receipt of the awards.
Read about how financial services firms are working to encourage an ethical culture and why it matters in our white paper created in conjunction with Coalition Greenwich, Conduct and Compliance: A Collective Approach to Ethics and Accountability.
Due diligence failures relating to investments or service providers
The Risk Alert notes two general areas of conduct observed in examinations that relate to due diligence.
- Lack of reasonable investigation into underlying investments or funds in accordance with their policies and procedures and failure to perform adequate due diligence on important service providers such as alternative data providers and placement agents.
- Inadequate policies and procedures regarding investment due diligence. For example, the staff observed private fund advisers that outlined a due diligence process in fund disclosures but did not maintain policies and procedures related to due diligence that was tailored to their advisory business.
Learn more about the importance of compliance policies and procedures in the on-demand webinar Minimizing the Risk of CCO Liability.
Use of potentially misleading “hedge clauses.”
Hedge clauses are provisions in agreements or statements set forth in other disclosures to clients that purport to limit an adviser’s liability or waive or limit their fiduciary duty. The Risk Alert notes that such clauses could be inconsistent with the Advisers Act.
Niknejad and Barakat recommend that private fund advisers should consider the following action points:
- Speak to staff about the importance of following the documented policies and procedures and documenting instances thereof.
- Perform a compliance audit or review to confirm written policies and procedures are being followed and identify any gaps.
- Make note of actions taken in the compliance review.
You can read more insight from Niknejad and Barakat about the risk alert in Sanne’s blog post SEC risk alert: Certain compliance issues for private fund advisers.
And if you'd like to learn more about how MyComplianceOffice helps firms manage disclosures and track adherence to policies and procedures, contact us today for a demo.
