SEC issues risk alert on private fund manager issues

Private equity and hedge fund managers have demonstrated conflict of interest and due diligence deficiencies, according to a risk alert published Thursday from the Securities and Exchange Commission's division of examinations.

The alert details observations on four deficient areas for private fund managers: failure to act consistently with disclosures; use of misleading disclosures regarding performance and marketing; due diligence failures relating to investments or service providers; and use of potentially misleading "hedge clauses."

The SEC published an alert in June 2020 detailing observations on private fund managers' conflicts of interest, fees and expenses, and policies and procedures related to insider trading. The latest alert provides additional observations.

The new alert highlights several failures private fund managers make in acting consistently with material disclosures to clients or investors, including failing to obtain informed consent from limited partner advisory committees, advisory boards or advisory committees required under fund disclosures, and failing to invest in accordance with fund disclosures regarding investment strategy. On the latter failure, examinations staff "observed private fund advisers that implemented an investment strategy that diverged materially from fund disclosures," the alert said. The division's staff "also observed advisers that caused funds to exceed leverage limitations detailed in fund disclosures."

On due diligence, staff observed "potential failures to conduct a reasonable investigation into an investment, to follow the due diligence process described to clients or investors, and to adopt and implement reasonably designed due diligence policies and procedures" pursuant to the Investment Advisers Act of 1940's compliance rule.

In response to these observations, many of the managers modified their practices to address the issues identified by SEC staff, according to the alert. "The division encourages private fund advisers to review their practices, and written policies and procedures, including implementation of those policies and procedures, to address the issues identified in this risk alert," the SEC said.

Chris Hayes, senior policy counsel with the Institutional Limited Partners Association, whose more than 500 member institutions represent more than $2 trillion in private equity assets, said in an email that ILPA is supportive of the need for robust SEC oversight of private fund advisers "to ensure that those advisers are following the terms of their agreements with investors."

He added, "Obviously a variety of issues are highlighted in the risk alert, and we intend to ensure LPs are aware of some of the issues that the SEC has uncovered so they can better incorporate these findings into their own due diligence processes."