The US Securities and Exchange Commission (SEC) has issued a risk alert that warns of “deficiencies” it has identified among private equity advisers that may have caused private fund investors to overpay fees and expenses.
The financial regulator said it uncovered three general areas of deficiencies: conflicts of interest, fees and expenses, and policies and procedures relating to material non-public information (MNPI). The findings came from an examination by the SEC’s Office of Compliance Inspections and Examinations (OCIE) of registered investment advisers (RIAs) that manage private equity funds or hedge funds.
Many of the deficiencies “may have caused investors in private funds to pay more in fees and expenses than they should have or resulted in investors not being informed of relevant conflicts of interest concerning the private fund adviser and the fund,” the SEC said in the alert. “OCIE encourages private fund advisers to review their practices, and written policies and procedures, including implementation of those policies and procedures.”
The alert is intended to help private fund advisers review and improve their compliance programs, and also to provide investors with information concerning private fund adviser shortcomings.
The OCIE said it observed conflicts of interest related to allocations of investments; multiple clients investing in the same portfolio company; financial relationships between investors or clients and the adviser; preferential liquidity rights; private fund adviser interests in recommended investments; co-investments; service providers; fund restructurings; and cross-transactions.
Regarding fees and expenses, the SEC said it found private fund advisers that inaccurately allocated fees and expenses, such as allocating shared expenses “in a manner that was inconsistent with disclosures to investors or policies and procedures, thereby causing certain investors to overpay expenses.”
It also said advisers charged private fund clients for expenses that they were not permitted to, such as salaries of adviser personnel, compliance, regulatory filings, and office expenses.
The OCIE also said advisers failed to comply with contractual limits on certain expenses that could be charged to investors, such as legal fees or placement agent fees, and that they failed to follow their own travel and entertainment expense policies.
And concerning MNPI, the SEC said advisers failed to address risks posed by their employees interacting with insiders of publicly traded companies, outside consultants arranged by “expert network” firms, or so-called value added investors such as corporate executives or financial professional investors who have information about investments.
The OCIE said it also observed private fund advisers that did not enforce policies and procedures addressing the risks to assess whether MNPI could have been exchanged. Additionally, advisers did not address risks posed by their employees who periodically had access to MNPI about issuers of public securities, for example, in connection with a private investment in public equity.
“OCIE examinations of private fund advisers have resulted in a range of actions, including no comment letters, deficiency letters, and, where appropriate, referrals to the Division of Enforcement,” the SEC said. “In response to these observations, many of the advisers modified their practices to address the issues identified by OCIE staff.”
The SEC’s risk alert comes shortly after the US Department of Labor (DOL) released an information letter clearing the way for the inclusion of private equity investments in defined contribution (DC) plans, such as 401(k)s. The department said defined contribution plan sponsors would not be violating their fiduciary duties solely by offering a managed asset fund with a private equity component as a designated alternative for individual retirement account plans.