On January 28, 2014,OCIE staff issued a risk alert (the “Risk Alert”) summarizing the results of more than ten examinations of SEC-registered investment advisers relating to the due diligence processes used by these advisers when recommending alternative investments such as hedge funds, private equity, venture capital, real estate and funds of private funds.
The Risk Alert discussed OCIE’s observations of current industry trends regarding advisers’ due diligence processes, including advisers’ efforts to obtain more information directly from managers of alternative investments through requests for position-level transparency and the use of separately managed accounts, use of third party service providers to supplement analyses and confirm information regarding alternative investments, performance of additional quantitative analyses and risk measures on alternative investments and their managers, and expansion of due diligence processes to include onsite visit requirements and review of operations, legal documents, liquidity issues and audited financial statements. According to the Risk Alert, these due diligence methods helped advisers identify risk indicators, which led advisers to perform additional due diligence or request changes to or reject an alternative investment.
The Risk Alert also highlighted deficiencies and weaknesses in some of the advisers examined, including omitting from their annual review a review of their due diligence policies and procedures for alternative investments, providing disclosures that were not consistent with their actual practices and failing to review disclosures for consistency with fiduciary principles owed to clients, providing potentially misleading or unsubstantiated claims in marketing materials, and not conducting periodic reviews of third party service providers.
In addition, the Risk Alert discussed advisers’ obligations with respect to codes of ethics, noting that where an adviser’s “access persons” are permitted to invest in a limited offering with preferential terms, there is an inherent conflict of interest that may influence the adviser’s due diligence process to the detriment of clients. The Risk Alert can be found here.