On Tuesday, June 23, 2020, the Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert aimed at registered investment advisers that manage private equity funds and hedge funds. The Risk Alert can be found here.
The Risk Alert identified three primary areas for deficiencies issued by OCIE to these advisers as a result of examinations. Each of the three areas is discussed in more detail below.
Conflicts of Interest
OCIE observed various conflicts of interest that it believed to be undisclosed or inadequately disclosed. The conflicts cited by OCIE involve:
- Conflicts related to allocations of investments.
- Conflicts related to clients investing in the same issuer, but through different investments (i.e., preferred stock vs. debt).
- Conflicts related to economic relationships between the adviser and select investors or clients.
- Conflicts related to preferential liquidity rights.
- Conflicts related to an adviser’s or its affiliates’ interest in recommended investments.
- Conflicts related to co-investments.
- Conflicts related to service providers.
- Conflicts related to fund restructurings.
- Conflicts related to cross-transactions.
Fees and Expenses
OCIE also identified issues surrounding fees and expenses associated with private funds and their advisers. The issues identified by OCIE include:
- Issues involving the allocation of fees and expenses.
- Inadequate disclosure surrounding the role and compensation of individuals rendering services to a fund, but are not the adviser’s employees.
- Issues involving valuation of a fund’s assets.
- For private equity funds, issues with respect to the receipt of fees from portfolio companies, such as monitoring fees, board fees, or deal fees.
Policies and Procedures Relating to Material Non-public Information (“MNPI”)
In what has become a recurring theme for the SEC, OCIE identified advisers that failed to establish, maintain, and enforce (1) written policies and procedures reasonably designed to prevent the misuse of MNPI, and (2) provisions in their code of ethics designed to prevent the misuse of MNPI.
If your firm is an adviser to any sort of private investment fund, it would be a wise investment to review the Risk Alert and your practices relating to the funds to ensure that none of these issues will subject your firm to an enforcement action.