SEC Issues Risk Alert on Observations From Exams of Private Fund Advisers

SEC Issues Risk Alert on Observations From Exams of Private Fund Advisers

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On June 23, 2020, the Division of Examinations (“EXAMS”) published a Risk Alert providing an overview of compliance issues observed by EXAMS staff in examinations of registered investment advisers that manage private funds. In light of the increasingly significant role of private fund advisers in the financial markets, the staff published another risk alert on Jan. 27, 2022 detailing additional observations from those examinations.

Observation #1: Failure to act consistently with disclosures

Advisers were observed:

  • Failing to follow practices described in their disclosures regarding the use of Limited Partner Advisory Committees, Advisory Boards or Advisory Committees (collectively “LPACs”). This included advisers failing to bring conflicts to the LPACs for review and consent, providing incomplete information to the LPAC, or obtaining consent after a transaction had already occurred.
  • Charging inaccurate management fees to investors as a result of (1) not following practices described in their disclosures related to the calculation of fund level management fees during the post-commitment period, and/or (2) extending the terms of a private equity fund without the required approvals or without following the liquidation provisions.
  • Executing investment strategies that deviated materially from the strategies disclosed to investors. Staff also observed advisers exceeding the leverage limitations described in fund disclosures.
  • Failing to accurately describe the “recycling” practices by the funds and in some cases causing advisers to collect excess management fees.
  • Failing to follow the LPA “key person” process after the departure of principals, or not providing investors with the status of departed key portfolio managers.

Observation #2: Use of misleading disclosures regarding performance and marketing

Advisers were observed:

  • Providing inaccurate or misleading disclosures about a track record, including (1) cherry-picking track records of one fund or a subset of funds, (2) failing to disclose how benchmarks were used, (3) failing to disclose how the track record was constructed, and/or (4) failing to disclose the material impact of leverage on performance.
  • Using inaccurate underlying data when creating track records, which resulted in inaccurate and potentially misleading performance disclosures. This included (1) data from incorrect time periods, (2) mischaracterization of return of capital distributions as dividends from portfolio companies, and/or (3) projected performance used in calculations instead of actual performance.
  • Failing to maintain books and records to support predecessor performance or omitting material facts about predecessor performance.
  • Making misleading statements related to awards received or failing to make full and fair disclosures about the awards.

Observation #3: Due diligence failures related to investments and service providers

Advisers were observed:

  • Failing to perform reasonable investigations of investments in accordance with fund disclosures and the advisers policies and procedures. The staff also observed advisers with policies and procedures related to due diligence of investments that were not properly tailored to the advisory business.
  • Failing to perform adequate due diligence on critical service providers, such as alternative data providers and placement agents.

Observation #4: Use of misleading “hedge clauses”

Advisers were observed:

  • Including potentially misleading hedge clauses in documents that purported to waive or limit the Advisers Act fiduciary duty except for certain exceptions, such as a non-appealable judicial finding of gross negligence, willful misconduct, or fraud. These clauses may be inconsistent with Sections 206 and 215(a) of the Advisers Act.

In light of this Risk Alert, Greyline recommends that advisers revisit their disclosure documents, marketing materials, and compliance policies and procedures as they relate to the observations by the EXAMS staff outlined above. Please reach out to your Greyline representative with any questions.

Read the SEC Risk Alert here.

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Darren Mooney

Partner and Co-Head of Business Development

Darren Mooney is a Partner and the Co-Head of Business Development at Greyline. Before joining Greyline, Darren served as deputy chief compliance officer of Partner Fund Management where he held primary responsibility for the compliance program of the second-largest hedge fund in the Bay Area. Prior to that, Darren spent five years providing compliance consulting services at Cordium and then ACA Compliance Group, where he led the company’s San Francisco office and west coast operations. In addition to providing ongoing consulting services to a variety of investment managers, including hedge fund, private equity, venture capital, real estate, quantitative and other wealth managers, Darren also regularly guided clients through the SEC registration process, implemented tailored compliance programs, supported clients’ live SEC exams, and served as an SEC-mandated independent compliance consultant following an SEC enforcement action. Darren’s other experience includes serving as deputy chief compliance officer and associate counsel at F-Squared Investments where he directly supported the compliance program during the investigation and subsequent enforcement regarding historical advertising practices. Darren has a B.S. in Economics from the University of Delaware and a J.D. from Suffolk University Law School. He is a member of the Massachusetts bar.

Annie Kong

Partner and Head of Venture Capital
Annie Kong is a Partner and Head of the Venture Capital Division at Greyline. She provides ongoing compliance consulting to investment advisers and manages client relationships. Prior to joining Greyline, Annie was part of compliance and operations at a long-only manager-of-managers that advised pension fund clients. While there, she conducted compliance and operational due diligence on SEC-registered investment advisers on the platform. She also oversaw and counseled on various legal matters across the firm. Annie has a B.A. in Economics from the University of California, San Diego, and a J.D. from the University of San Diego School of Law. She is an active member of the State Bar of California.
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