On June 23, the U.S. Securities and Exchange Commission (SEC) Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert focused on compliance issues observed during its examinations of hedge fund and private equity fund managers. The Risk Alert noted that more than 36 percent of all SEC-registered investment advisers manage at least one private fund. This is a clear signal that the OCIE spotlight will be shining brightly on the activities of fund managers in 2021.
The guidance in the Risk Alert does not chart any new compliance territory; many of these themes can be traced back to previous staff positions and prior SEC enforcement actions. However, this is the first time that an OCIE Risk Alert has been devoted solely to fund managers, making it a valuable tool for fund managers to use in reviewing and implementing their policies and procedures.
The Risk Alert identified the following three key areas where OCIE staff commonly saw deficiencies in examinations of private fund advisers: (i) conflicts of interest, (ii) fees and expenses, and (iii) policies and procedures to prevent the misuse of material nonpublic information (MNPI).
OCIE staff found that private fund advisers failed to provide adequate disclosure with respect to, or were otherwise deficient in their handling of, the following conflicts of interest:
OCIE staff noted the following common issues with how private advisers disclose and allocate fees and expenses, which often leads to certain investors being overcharged:
OCIE noted several deficiencies in private funds' compliance with Section 204A of the Investment Advisers Act of 1940, as amended, and Rule 204A-1 (commonly known as the code of ethics rule). In particular, OCIE staff found that private fund advisers violated Section 204A or Rule 204A-1 by failing to address risks posed by:
In addition, OCIE staff noticed deficiencies in private funds' establishment, maintenance and enforcement of provisions in their codes of ethics reasonably designed to prevent misuse of MNPI. In particular, advisers failed to enforce their own policies regarding trading restrictions in respect of securities placed on the "restricted list," receipt of gifts and entertainment from third parties, and securities holdings and transaction reporting requirements applicable to access persons. The prevalence of the issues noted in the Risk Alert emphasizes the need for private fund managers to take a close look at how they collect MNPI, how they document the receipt of MNPI, and how their policies and procedures ensure that MNPI is not mishandled, internally or externally.
The SEC's compliance approach follows a well-established pattern: first, the SEC identifies compliance issues and publishes its priorities; second, the SEC issues a Risk Alert to the industry; and third, the SEC focuses on these identified issues during examinations and issues deficiency letters and pursues enforcement actions against advisers who have failed to heed the warnings.
Now is the time for private fund advisers to revisit their written policies and procedures, using the Risk Alert as a checklist. Disclosure issues continue to persist because of the complexity inherent in identifying when certain activities may constitute a conflict of interest. Monitoring potential conflicts requires vigilance on a day-to-day basis. Even those fund managers that have modified their disclosures to comport with the Risk Alert need to continually monitor their operations to ensure that they are complying with their disclosed procedures regarding conflicts, calculation of fees and handling of MNPI. To that end, advisers should regularly compare/contrast their policies to their firm's actual day-to-day practice, provide compliance training to their employees, and issue reminders to employees to reinforce compliance with existing policies and procedures.
Should you have any questions concerning this Risk Alert or investment adviser compliance in general, please contact any of the authors of this advisory or any members of the Day Pitney Investment Management and Private Funds group.
 See Investment Advisers Act of 1940 Release No. 5510, dated May 26, in which the SEC found that Ares Management LLC, a registered investment adviser (Ares), obtained potential MNPI about a portfolio company through an Ares senior employee who sat on the company's board; Ares later purchased a large portion of the company's stock. The SEC's order in this case cited Ares' failure to implement its policies and procedures to prevent the use of MNPI.
Day Pitney Alert
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Day Pitney Press Release
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