David Topol

In the following guest post, David Topol of the Wiley law firm takes a look at the SEC’s recently increased focus on investment advisers who manage private funds and examines the areas on which the SEC is focusing. I would like to thank David for allowing me to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is David’s article.


The United States Securities and Exchange Commission has increased its focus in recent years on investment advisers who manage private funds. The Division of Enforcement of the SEC reported that in fiscal year 2019, 36% of all civil and stand-alone administrative proceedings were brought against investment advisers and investment companies.


The fiscal year 2020 report of the SEC’s Office of Compliance Inspections and Examinations (the “OCIE”) on “Examination Priorities” identified examinations of registered investment advisers (“RIAs”) for private funds as one of its priority areas. Among other things, the OCIE stated that it “will continue to focus on RIAs to private funds that have a greater impact on retail investors, such as firms that provide management to separately managed accounts side-by-side with private funds.” The OCIE also explained that it will continue to examine investment advisers to private funds “to prevent the misuse of material, non-public information and conflicts of interest,” to monitor improper practices with respect to fees, and to evaluate the use of affiliates of investment advisers that provide services to clients.


The SEC provided additional insight into its areas of focus with respect to investment advisers of private funds on June 23, 2020, when the OCIE issued a risk alert entitled Observations from Examinations of Investment Advisers Managing Private Funds (the “Risk Alert”). The OCIE typically issues only five to six risk alerts a year, so a risk alert provides important guidance on SEC examination and enforcement priorities. The Risk Alert provides OCIE’s “observations from [its] examinations as well as common deficiencies and compliance issues.” The Risk Alert identifies three areas where the OCIE has observed deficiencies. Not surprisingly, these three areas align with the OCIE’s examination priorities: conflicts of interest; fees and expenses; and the use of material non-public information.


Conflicts of Interest. The SEC regulations implementing the Investment Advisers Act of 1940 require that investment advisers eliminate or fairly disclose all potential conflicts of interest. The Risk Alert identifies several areas where the Commission has observed conflicts of interest for investment advisers of private funds. The conflicts identified by the OCIE include the following:


Conflicts relating to investment allocations. A single investment adviser often manages multiple funds or other investment vehicles. The Risk Alert notes that the SEC has observed several resulting conflicts of interest. For example, a fund adviser may allocate limited investment opportunities only to some clients, including based on differences in fees paid to the adviser. The adviser may also allocate securities at different prices to different customers.


Conflicts relating to multiple clients investing in the same portfolio company. Private equity firms invest in portfolio companies in different ways. For example, a firm might acquire equity in a portfolio company, and it might extend credit to the same company. When the firm has different clients investing in different levels of the capital structure, conflicts can arise when the interests of the different levels or types of investment are not aligned. For example, if a portfolio company is approaching insolvency, the equity holders, who would be wiped out by a bankruptcy, may be more willing to take on risk than the secured lenders who would prefer a sale of assets or orderly liquidation that would ensure that their investment is repaid even if the equity is wiped out.


Conflicts resulting from relationships with clients. The Risk Alert notes that the OCIE has observed situations in which advisers have failed to make adequate disclosures about economic relationships with select investors or clients who may have provided the seed money for the funds or may have an economic interest in the adviser. Similarly, the Risk Alert explains that sometimes private fund advisers enter into side agreements with individual clients that provide special terms, including preferred liquidity rights, to those clients. In a time of market disruption, these side agreements can provide certain clients with preferential market advantages that are not disclosed to other clients.


Conflicts relating to service providers. Private equity firms sometimes use related entities to provide services to portfolio companies. This can be beneficial for investors by creating efficiencies, particularly when the private equity firm invests in multiple portfolio companies in the same space. At the same time, the Risk Alert explains that the SEC has observed conflicts of interest from such arrangements. The OCIE reports that some firms do not follow their own procedures to ensure that the services provided by the affiliated entity are on terms that are at least as favorable as those that could be obtained from an unaffiliated third party. The Risk Alert also notes that some private fund advisers fail to disclose that services are being provided by related entities or fail to disclose other benefits, such as incentive payments, flowing back to the adviser.


Fees and Expenses. The Risk Alert identifies fees and expenses as a second area where the OCIE has identified deficiencies by investment advisers. The deficiencies include both failures in disclosures to investors as well as in the adviser’s compliance with its own procedures. Among other things, the Risk Alert notes:


Asset Valuation. The Risk Alert reports that the OCIE has found that some investment advisers have not followed their own, internal procedures for valuing assets. Since management fees and carried interest are based on the valuation of fund assets, this can result in the investment adviser overvaluing assets and taking too much money from the funds.


Allocation of fees and expenses. The Risk Alert notes that some advisers have improperly allocated shared fees and expenses among various funds to favor some investors while causing other investors to overpay for fees and expenses.


Improper Fees and Expenses. The Risk Alert identifies several ways in which OCIE examinations have uncovered improper fees and expenses. These includes charging for fees and expenses that are not permitted (such as adviser-related expenses), failing to adhere to travel and entertainment expense policies, and improperly calculating management fee offsets from portfolio companies.


Material Non-Public Information / Code of Ethics. The Investment Advisers Act of 1940 requires investment advisers to establish, maintain and enforce written policies and procedures to prevent the use of material non-public information. The implementing regulations require registered investment advisers to adopt and maintain a code of ethics to address the use of material non-public information.


The Risk Alert identifies deficiencies by investment advisers in complying with these requirements. For example, it notes that some advisers are failing to take measures to ensure that employees are not trading with the benefit of non-public obtained from insiders of publicly traded companies, outside consultants or other sources. OCIE also reports that some advisers fail to enforce trading limits for securities on their “restricted list” or to ensure proper preclearance of trades.




As private funds, which now have more than $14 trillion in assets under management, have grown, the SEC has devoted increasing attention to their operations and to the investment advisers managing those funds. The Risk Alert provides relevant guidance in identifying areas of focus for the SEC when it examines private funds and their investment advisers, reinforcing that there will be increasing attention on conflicts of interests, improper fees, and trading based on non-pubic information. And since OCIE examinations are frequently a source of referrals to the SEC’s division of enforcement, the guidance confirms that there will continue to be enforcement actions in these areas.