The Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert on June 23, 2020 describing common deficiencies in exams of advisers to private equity and hedge funds (collectively “private fund advisers.”) Common themes identified by OCIE were the following deficiencies: inadequate disclosure of conflicts of interest; inaccurate assessment or disclosure of fees and expenses; and inadequate policies and procedures to prevent the misuse of material non-public information and inadequate codes of ethics.
Of interest for this posting are the following findings and observations regarding conflicts of interest that appear to be inadequately disclosed and deficiencies under Section 206 of the Investment Advisers Act of 1940 (“Advisers Act”) or Advisers Act Rule 206(4)-8:
- 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
- Service providers
- Fund restructurings
Advisers Act Release No. IA-5248 (June 5, 2019), Commission Interpretation Regarding Standard of Conduct for Investment Advisers, reinforced the requirements and standards set forth under Advisers Act Section 206 and Rule 206(4)-8, including an advisers duty of loyalty, stating the following: “The duty of loyalty requires that an adviser not subordinate its clients’ interests to its own. In other words, an investment adviser must not place its own interest ahead of its client’s interests. To meet its duty of loyalty, an adviser must make full and fair disclosure to its clients of all material facts relating to the advisory relationship.”
NRS recommends that private fund advisers review the Risk Alert and IA-5248 to assess the adequacy of their disclosure documents, contracts/agreements, policies and procedures and testing of such based on your business activities and practices to ensure your supervisory, compliance, and/or risk management processes address the risks identified in the Risk Alert.
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