On June 23, 2020, the U.S. Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations (OCIE) issued a risk alert to provide an overview of certain compliance issues and deficiencies observed in examinations of registered investment advisers that manage private equity funds or hedge funds (“private fund advisers”).
Although most of the risks and deficiencies identified appear to involve enhanced disclosures, some also appear to advocate for additional policies or controls associated with the administration of select policies, including those related to conflicts of interest and MNPI/code of ethics.
Notably, OCIE also mentioned:
- The SEC has brought enforcement actions on several of the issues discussed in the risk alert
- Many of the deficiencies discussed may have caused investors in private funds to pay more in fees and expenses than they should have or resulted in investors not being informed of relevant conflicts of interest concerning the private fund adviser and the fund
OCIE stated it continues to observe some of these practices during examinations, which, in ACA’s view, suggests these risks will be evaluated in subsequent examinations of private fund advisers and will undoubtedly become a part of the exam staff arsenal going forward.
Conflicts of Interest
Citing Section 206 of the Investment Advisers Act of 1940 (“Advisers Act”) and Rule 206(4)-8, OCIE staff observed inadequate disclosure and deficiencies related to the following conflicts of interest:
- 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
- Coinvestment vehicles
- Service providers including the use of affiliates
- Fund restructurings
- Cross transactions
Fees and Expenses
Once again citing Section 206 or Rule 206(4)-8 of the Advisers Act, OCIE noted the following fee and expense issues that appear to be deficiencies:
- Inappropriate allocation practices
- Impermissible expenses when considering current disclosures
- Noncompliance with expense caps
- Noncompliance with travel and entertainment expense policies or disclosures
- Inadequate disclosure associated with the role and compensation of Operating Partners
- Client assets were not valued in accordance with valuation processes or disclosures
- Inaccurate management fee and offset calculations
- Inadequate fee income (e.g., operating partner compensation, portfolio company fees) tracking processes and disclosures
- Inadequate accelerated monitoring fee disclosures
MNPI / Code of Ethics
Referencing Section 204A of the Advisers Act, OCIE staff observed the following issues related to written policies and procedures to prevent the misuse of MNPI that appear to be deficiencies:
- Inadequate policies and lack of enforcement of policies related to insiders of publicly traded companies, use of expert networks, and “value added investors” (e.g., corporate executives or financial professional investors that have information about investments).
- Inadequate policies to address the risks associated with physical (i.e., office space) and technological access to MNPI
- Inadequate policies to address the risks associated with wall crossings and confidentiality agreement processes
Referencing Advisers Act Rule 204A-1 (“Code of Ethics Rule”), OCIE staff observed the following issues that appear to be deficiencies:
- Inadequate policies and lack of enforcement of policies related to the firm’s “restricted list”
- lack of enforcement of gift and entertainment requirements of the advisers’ code of ethics
- Inadequate administration of personal trading policies and procedures or requirements under the Code of Ethics Rule related to personal trading
- Inadequate processes for the identification of “access persons”
If past OCIE Risk Alerts are an indicator, these risk areas could be a focus of the SEC exam staff for the foreseeable future. Consequently, private fund advisers should consider conducting a gap analysis against their current policies, processes, and disclosures to not only improve the firm’s compliance program but also to enhance OCIE examination readiness.
How We Help
ACA provides code of ethics administration support and personal trading surveillance technology for managing employee compliance and identifying potential conflicts of interest, insider trading, market abuse, and other misconduct. We also conduct mock regulatory examinations, policy and procedure reviews, and various surveillance reviews and analysis to help our private equity and hedge fund clients identify potential issues and areas for improvement.
For more information on how we can assist you, please contact us here or reach out to your ACA consultant.