Tips for Updating Your Compliance Program: SEC Exam Observations Risk Alert

Conduct inconsistent with disclosures 

Advisers failed to follow their offering document disclosures regarding: 

1. the role of an Advisory Board or Advisory Committee, especially concerning conflicts 
2. liquidation and fund extension terms and “recycling” practices 
3. management fee calculations, especially for private equity funds during the Post-Commitment period 
4. investment strategy terms 
5. adviser personnel changes

Firms should implement procedures required under their offering documents. If an Advisory Board vote is needed in certain instances, consider establishing a process for obtaining and documenting the vote. Periodically review and refresh offering documents to verify that actual practices are aligned. Look for ways to enhance fee calculation processes, testing, and oversight.

Inaccurate or misleading disclosures on performance and marketing

Track record: Disclosures lacked detail about benchmarks and the use of leverage. Portfolio construction processes did not correspond to disclosures, and included stale data or cherry-picked time periods 

Inaccurate calculations: Calculations based on underlying data and materials that reported projected rather than actual returns.   

Portability: EXAMS noted books & records weaknesses in ported return history. Firms also failed to adequately make the case mainly that the individual(s) were “primarily responsible” for the prior track record. 

Awards: Materials describing awards failed to disclose required elements, such as the criteria associated with the award and the amount of any fee paid by the advisor to participate or promote its receipt of the award.

Firms should consider whether their policies and procedures to review marketing materials are robust enough to catch these potential violations. Consider periodic reviews of the calculation process and interview those responsible. Review ported track records and related backups before including them in marketing materials. 

Due diligence failures relating to investments or service providers 

Advisers did not adhere to policies and procedures for conducting reasonable due diligence of fund investments (including the compliance and internal controls of the underlying investments or private funds in which they invested) or their third-party service providers (such as alt data providers and placement agents). Some advisers described their process in due diligence questionnaires (DDQs) and other materials, but failed to have adequate and corresponding policies and procedures.

Firms should consider the adequacy of their policies and procedures for investment and service provider due diligence. DDQs sometimes force firms to describe their investment research process in writing in greater detail than a firm’s compliance manual. Compliance personnel should consider incorporating language from the DDQs into existing compliance procedures.  

Use of potentially misleading "hedge clauses" 

EXAMS noted firms used offering documents with clauses 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.

Firms should take a new look at their offering documents (and investment advisory contracts) to ensure they do not contain liability waivers that contravene an adviser’s fiduciary duties.