The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) conducted a series of examinations into private fund advisers. See https://www.sec.gov/files/Private%20Fund%20Risk%20Alert_0.pdf. To say the least, OCIE was not pleased with the results, indicating a significant percentage of these advisers had compliance issues.  In particular, OCIE found problems with: (1) conflicts of interest; (2) fees and expenses; and (3) material non-public information policies and procedures.

OCIE found that these private advisers had numerous conflicts of interest issues, noting that these issues may be violations of the Investment Advisers Act of 1940 (“Advisers Act”). In particular, the conflicts of interest related to: (1) investment allocations; (2) multiple clients; (3) financial relationships between clients/investors and the adviser; (4) preferential liquidity rights; (5) advisers having interests in recommended investments; (6) coinvestments; (7) service providers; (8) fund restructurings; and (9) cross-transactions. OCIE believed these conflicts were not being addressed by private fund advisers. Such commentary indicates that the SEC Staff will take action in the future if it continues.

Additionally, OCIE indicated problems with fees and expenses allegedly being perpetrated by private fund advisers. For example, OCIE found the difficulties with: (1) fee and expense allocations with sharing of expenses, among other things; (2) fees and expenses for “Operating partners” without adequate disclosure; (3) valuation; and (4) monitoring/board/deal fees and fee offsets. These items may create financial irregularities causing greater problems in the operation of the funds, and, as such, the SEC Staff may consider these problems to rise to the level of actual Advisers Act violations.

Finally, OCIE identified ethical issues relating to the use and handling of material non-public information. OCIE found that private fund advisers needed to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of non-public material information in that the private fund advisers had to address insiders, outside consultants, and employees. Private fund advisers also apparently were missing procedures involving trading restrictions, gifts and entertainment, among other things.

In short, these findings should serve as a wake-up call for private fund advisers. It demonstrates the need for proper procedures in consultation with securities counsel before the SEC Enforcement Staff comes knocking at the door.

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