SmartRIA Risk Alert

On June 23, 2020, the SEC published a Risk Alert, which summarized compliance issues discovered during hundreds of examinations of investment advisers that manage private equity funds or hedge funds. Examiners from the SEC’s Office of Compliance Inspections and Examinations (OCIE) made a number of observations that can help private fund advisers to revise and improve their policies and procedures. Advisers can also use OCIE’s findings to avoid committing similar mistakes at their own firms.

The Risk Alert is a must-read for private fund advisers. In the Risk Alert, OCIE reported that over 36 percent of investment advisers registered with the SEC manage private funds. The Risk Alert focused on three areas:

  1. Conflicts of interest;
  2. Fees and expenses; and
  3. Material non-public information (MNPI) policies and procedures.

Examiners observed that these deficiencies caused investors to incur higher costs, and they did not receive full disclosure of the adviser’s conflicts of interest.

Private fund advisers must make full disclosure of conflicts of interest

Rule 206(4)-8 under the Investment Advisers Act prohibits advisers to pooled investment vehicles from making untrue statements of a material fact or omitting material facts. These untrue statements and omissions may mislead a prospective investor or a current one. Examiners observed that some private fund advisers failed to disclose conflicts of interest pertaining to:

  • Allocations of investments;
  • Multiple clients investing in the same portfolio company;
  • Financial relationships between the adviser and investors or clients;
  • Side letters granting preferential liquidity rights;
  • Interests in recommended investments;
  • Co-investment vehicles and co-investors;
  • Service providers;
  • Cross-transactions; and
  • Fund restructurings.

Fund restructurings are transactions in which a private fund adviser arranges the sale to a purchaser of an existing private fund or the fund’s portfolio.

Fees and expenses

Examiners found that investors sometimes paid inflated fees and expenses because private fund advisers improperly allocated shared expenses. The advisers’ allocations were inconsistent with policies and procedures, as well as their disclosures to investors. Some advisers did not adequately disclose operating partners’ roles and compensation.

In some instances, clients were charged for expenses that were not allowed by the fund’s operating agreements. Advisers also failed to comply with the contractual limits on certain expenses and did not adhere to their travel and entertainment expense policies and procedures. In addition, certain advisers received fees from portfolio companies and neglected to apply or calculate management fee offsets. Some advisers’ valuation processes did not match the firm’s policies and procedures or its disclosures.

MNPI policies and procedures and codes of ethics issues

The Risk Alert noted that private fund advisers did not always implement, maintain, and enforce their code of ethics to guard against the misuse of MNPI. Some advisers failed to enforce the firm’s securities trading restrictions. They also did not implement well-drafted policies and procedures for adding and deleting securities from the restricted list. In addition, they did not require access persons to submit transactions and holdings reports within the appropriate timeframe or to submit personal securities transactions for preclearance in accordance with the firm’s code of ethics. Some private fund advisers failed to identify access persons correctly and did not enforce the gifts and entertainment provisions in their code of ethics.

The advisers examined did not address the MNPI that arises when employees interact with public company insiders, outside consultants arranged by an expert network firm, or value-added investors, such as corporate executives or financial professional investors. They did not evaluate whether non-public information could have been exchanged.


According to the Risk Alert, certain examinations resulted in deficiency letters and referrals to the SEC’s Division of Enforcement. Although some of the firms examined were not cited for compliance deficiencies, private fund advisers would be wise to get ready for a visit from examiners.

When it publishes a Risk Alert, OCIE is warning advisers that they should be careful to avoid similar deficiencies. Advisers that manage private funds should take note of this particular Risk Alert and should bolster their policies and procedures in the problem areas identified by examiners. Private fund advisers should also make certain that advisory personnel are strictly adhering to those policies and procedures.

The SEC Risk Alert can be found at the following LINK.

This SEC Risk Alert was provided by SmartRIA partner RIA Compliance Group.

Request a Free Demo