SEC Exam Risk Alert on Private Fund Advisers

On January 27, 2021 the Division of Examinations of the Securities and Exchange Commission published their second risk alert focused on Private Fund Advisor deficiencies commonly noted in connection with their examinations.

These include:

Conduct Inconsistent with Disclosures

• Failure to obtain informed consent from Limited Partner Advisory Committees, Advisory Boards or Advisory Committees (collectively “LPACs”) required under fund disclosures.
• Failure to follow practices described in fund disclosures regarding the calculation of Post-Commitment Period fund-level management fees.
• Failure to comply with LPA liquidation and fund extension terms.
• Failure to invest in accordance with fund disclosures regarding investment strategy.
• Failures relating to recycling practices.
• Failure to follow fund disclosures regarding adviser personnel

Disclosures Regarding Performance and Marketing

• Misleading material information about a track record
• Inaccurate performance calculations.
• Portability – failure to support adequately, or omissions of material information about, predecessor performance
• Misleading statements regarding awards or other claims.

Due Diligence

• Lack of a reasonable investigation into underlying investments or funds
• Inadequate policies and procedures regarding investment due diligence.

Hedge Clauses

• The EXAMS staff noted that whether a clause in an agreement, or a statement in disclosure documents provided to clients and investors, that purports to limit an adviser’s liability (a “hedge clause”) is misleading and would violate Sections 206(1) and 206(2) of the Advisers Act depends on all of the surrounding facts and circumstances. EXAMS staff observed “private fund advisers that included 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.” It further noted that, “such clauses could be inconsistent with Sections 206 and 215(a) of the Advisers Act.”

Our take:

Private fund advisers should carefully review these areas, as these will likely be a continued area of focus for future exams.  One key takeaway is to carefully follow the terms of the Fund’s governing documents.  Another is to be very careful with any performance disclosures – to make sure they are both fully accurate, not just at the time of the fund launch, but also to ensure that these remain accurate as long as fund interests are being offered.  Finally, it is important to make sure fund managers maintain full and complete records on the underlying calculations for any performance information.

With respect to “hedge clauses,” fund manager’s should carefully review their fund organizational documents, and PPM.  In the past, many fund manager’s have included exculpation clauses in the Fund’s limited partnership agreement that may now be seen as a violation of the Adviser’s Act.  These provisions should be reviewed carefully in light of the SEC’s focus on these clauses, and potentially amended to ensure compliance.

A copy of the full alert can be found here: https://www.sec.gov/files/private-fund-risk-alert-pt-2.pdf

Please do not hesitate to contact any member of Rimon’s Investment Management group with any questions.