On June 23, 2020, the Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert focused on assisting private fund advisers in reviewing and enhancing their compliance programs, as well as providing information to investors regarding potential private fund adviser deficiencies. In the Risk Alert, OCIE addresses three general areas of concern: (i) conflicts of interest, (ii) fees and expenses, and (iii) policies and procedures relating to material non-public information (MNPI). OCIE found over 36 percent of registered advisers managed private funds, and through its examinations, it has found the following commonalities.
Conflicts of Interest
Advisers are prohibited under Section 206 of the Advisers Act of defrauding or otherwise misleading clients as well as making full and fair disclosure of all conflicts of interest such that a client can provide informed consent to any conflicts. More specifically, Rule 206 (4)-8 of the Advisers Act prohibits advisers to pooled investment vehicles from making untrue statements, omitting to state a material fact, or otherwise engaging in a deceptive manner to an investor in a pooled investment vehicle. OCIE, during its examinations, noted the following conflicts of interest that were often inadequately disclosed under Rule 206(4)-8: the allocations of investments; multiple clients investing in the same portfolio; financial relationships between investors or clients and the advisor; preferential liquidity rights; private fund adviser interests in recommended investments; co-investment vehicles and other co-investors; service providers; fund restructurings; and cross-transactions.
Fees and Expenses
Over the course of its examinations, OCIE observed the following areas where fee and expense issues appeared deficient: improper or inaccurate allocation of fees and expenses; inadequate disclosure regarding the role and compensation of individuals, who are not adviser employees, providing services to the private fund or portfolio companies; valuation of client assets in accordance with the adviser’s valuation process; and issues regarding the receipt of fees from portfolio companies such as monitoring fees, board fees, or deal fees.
MNPI / Code of Ethics
Section 204A of the Advisers Act requires advisers to establish, maintain and enforce written policies designed to prevent the misuse of MNPI. Advisers are also required under Advisers Act Rule 204A-1, otherwise known as the Code of Ethics Rule, to adopt and maintain a code of ethics which sets forth standards of conduct for the firm as well as addresses conflicts arising from personal trading by firm personnel. Recent OCIE examinations have revealed several areas where deficiencies appeared under Section 204A due to firms not addressing risks posed by their personnel interacting with: insiders of publicly traded companies; outside consultants arranged by “expert network” firms; (iii) “value added investors” (e.g. corporate executives). Additionally, OCIE noted the following additional recurring issues related to Rule 204A-1: firms not enforcing trading restrictions related to the firm’s restricted list; failing to enforce requirements in their code of ethics relating to receipt of gifts and entertainment from third parties; and failing to require access persons to submit transactions and holdings reports in a timely manner.
Resources
https://www.sec.gov/files/Private%20Fund%20Risk%20Alert_0.pdf