SEC Private Fund Adviser Risk Alert, Decoded
Articles by: Richey May, Feb 16, 2022
In January, the Securities and Exchange Commission’s Division of Examinations announced its annual examination priorities.
The Division publishes these priorities in the form of a risk alert to raise awareness of sources of potential risk to investors and to protect the integrity of the U.S. capital markets. Among those are conflicts of interest for brokers and investment advisers, as well as related risks to FinTech initiatives in general. In recent years, the Division has uncovered numerous failures in these areas, as well as many instances of misleading disclosures around performance and marketing.
Our team put together a summary of the SEC’s most up-to-date examination observations and priorities. We encourage you to review your disclosures, marketing and compliance programs accordingly. Here are the highlights of the deficiencies the SEC noted in their risk alert:
Conduct inconsistent with disclosures
- Informed Consent from LPACs. A number of private fund advisers failed to bring conflicts for review and consent to their LPACs or to provide adequate disclosure and/or obtain consent before completing those transactions.
- Calculation of Management Fees. Private fund advisers failed to reduce the cost basis of an investment after selling, writing off or writing down an investment, subjecting investors to higher management fees.
- LPA Liquidation. Advisers extended the terms of private equity funds without obtaining required approvals or complying with liquidation provisions, possibly charging investors inappropriate management fees in the process.
- Disclosures. Private fund advisers failed to comply with investment limitations in fund disclosures, including implementing investment strategies that deviated from fund disclosures.
- Recycling. Advisers made vague or inadequate disclosures when describing “recycling” practices used to reinvest realized investment proceeds in the fund.
- Adviser Personnel. Advisers failed to follow the fund’s “key person” process after the departure of key principals or portfolio managers.
Disclosures regarding performance and marketing
Along with the deficiencies outlined above, please note that the SEC has revised its marketing rules. Fund advisers must comply with the new rules by November 4, 2022.
Under the current marketing rules, examinations staff observed the following misleading or inaccurate performance disclosures:
- Misleading track record information. Cherry-picking, failure to disclose the impact of leverage, improper use of benchmarks, stale performance information, and failure to reflect fees and expenses were among the cited deficiencies.
- Inaccurate performance calculations. Misrepresenting performance calculations to investors, including using incorrect time periods, mischaracterizing return of capital distributions as dividends and/or projected versus actual performance in track records.
- Predecessor performance. Failure to maintain books and records supporting predecessor performance, including marketing incomplete prior track records.
- Misleading statements. Private fund advisers made misleading statements about their firm’s awards, such as failing to make full and fair disclosures about the awards, including the criteria for obtaining them and fees paid to receive or promote them.
At Richey May, we make it a priority to prepare our clients to remain compliant and conduct their business consistent with their disclosures. SEC risk alerts serve as critical guidance for investment advisers.
Keep in mind that the SEC can conduct an exam at any time, for any reason, announced or unannounced. Compliance deficiencies can subject your firm to fines or more intense scrutiny. Word to the wise: Stay informed and stay ahead.