On January 27, 2022, the Securities and Exchange Commission (SEC) Division of Examinations (EXAMS) released a new risk alert “Observations from Examinations of Private Fund Advisers” providing an overview of compliance issues observed by
EXAMS staff in examinations of registered investment advisers (RIA) that manage private equity funds or hedge funds (collectively, “private fund advisers”). The four primary areas of deficiencies noted in this risk alert include: 1) failure to act consistently with disclosures, 2) use of misleading disclosures regarding performance and marketing 3) due diligence failures relating to investments or service providers, and 4) use of potentially misleading “hedge clauses.”
Below we discuss the compliance deficiencies highlighted in this advisor compliance risk alert.
This risk alert details additional observations supplementing the Investment Advisers Managing Private Funds Risk Alert published in June 2020, highlighting observed deficiencies for conflicts of interest, fees and expenses, and policies and procedures related to insider trading. We’d like to stress the importance of the Chief Compliance Officer (CCO) of all RIA firms to review both risk alerts.
It’s also important to note that the examinations were conducted for advisers that manage private funds.
EXAMs observed a wide range of compliance issues; below we provide an overview of the four categories of compliance deficiencies highlighted in the risk alert:
Conduct Inconsistent with Disclosures
The risk alert details the following failures to act consistently with material disclosures to
clients or investors as observed by EXAMS staff:
- Failure to obtain informed consent from Limited Partner Advisory Committees, Advisory
Boards or Advisory Committees (collectively “LPACs”) required under fund disclosures. - Failure to follow practices described in fund disclosures regarding the calculation of
Post-Commitment Period fund-level management fees. - Failure to comply with LPA liquidation and fund extension terms.
- Failure to invest in accordance with fund disclosures regarding investment strategy.
- Failures relating to recycling practices.
- Failure to follow fund disclosures regarding adviser personnel.
Disclosures Regarding Performance and Marketing
EXAMS staff observed private fund advisers providing to investors or prospective investors
misleading track records or other marketing statements that appear to violate Rule 206(4)-8. They also observed failures by private fund advisers to maintain these required records. The following deficiencies are detailed in the risk alert:
- Misleading material information about a track record.
- Inaccurate performance calculations.
- Portability – failure to support adequately, or omissions of material information about,
predecessor performance. - Misleading statements regarding awards or other claims.
Due Diligence
EXAMS staff observed potential failures to conduct a reasonable investigation into an
investment, to follow the due diligence process described to clients or investors, and to adopt and
implement reasonably designed due diligence policies and procedures pursuant to the
Compliance Rule. The first due diligence deficiency noted in the risk alert was a lack of a reasonable investigation into underlying investments or funds. Followed by inadequate policies and procedures regarding investment due diligence.
Hedge Clauses
The risk alert notes “EXAMS staff observed private fund advisers that included potentially misleading hedge clauses in documents that purported to waive or limit the Advisers Act fiduciary duty except for certain exceptions, such as a non-appealable judicial finding of gross negligence, willful misconduct, or fraud. Such clauses could be inconsistent with Sections 206 and 215(a) of the Advisers Act.”
Once again, we highly recommend that the CCO and all advisory firm principals carefully review this latest SEC RIA compliance risk alert.