Memorandum
SEC Announces Enforcement Action Regarding Failure to Disclose
Conflict of Interest Created by Outside Business Activity

April 23, 2015

On April 20, the SEC announced that it had reached a settlement with a prominent investment manager (the“Firm”) regarding alleged breaches of the Firm’s fiduciary duties under the U.S. Investment Company Act of1940, as amended (the “1940 Act”), and the U.S. Investment Advisers Act of 1940, as amended (the“Advisers Act”), as applicable (the “Order”). The breaches alleged by the SEC stem from a failure by the Firmto (1) disclose a conflict of interest involving the outside business activity of one of the Firm’s portfolio
managers, (2) adopt and implement written compliance policies and procedures concerning the outsidebusiness activities of the Firm’s employees, how they should be assessed and monitored for conflict purposes
and when they should be disclosed; and (3) report violations of the Firm’s private investment policy to theregistered funds’ boards of directors as a “material compliance matter” pursuant to Rule 38a-1 under the1940 Act. This alert focuses on the topic of assessing, mitigating and monitoring conflicts of interest
associated with outside business activities for registered investment advisers, including advisers to bothregistered funds and unregistered/private funds more generally (and does not evaluate or comment
specifically on the conduct that was the subject of the settlement with the Firm, which the Firm neither
admitted nor denied).
Generally, in order to comply with its fiduciary duties under the Advisers Act and the 1940 Act, as applicable,
a fund sponsor adopts compliance policies, often as part of its code of ethics, that prohibit employees fromengaging in outside business activities without the prior written approval of the fund sponsor’s chiefcompliance officer. As part of its procedures under these policies, the fund sponsor typically requires a new
employee to disclose to the CCO any outside business activities in which the employee would like to continue
to engage upon hiring and obtains annual attestations from its employees that they are not engaging in any
outside business activities other than those that have been disclosed to, and approved by, the CCO. Most
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firms also have a policy, and/or receive attestations, that employees will obtain the CCO’s prior approval
before engaging in any future outside business activities. To the extent an employee is engaging in approved
outside business activities, a fund sponsor generally requires the employee to inform the CCO of any changes
in, or material conflicts of interest relating to, the approved outside business activities of which the employee
becomes aware in the future.
The circumstances surrounding the SEC’s findings in the Order are a reminder that fund sponsors shouldalso consider implementing policies and procedures that address how they will assess the outside businessactivities of their employees for conflicts purposes, including who is responsible for deciding whether an
outside business activity should be permitted, the types of activities that will or will not be permitted andhow permitted activities will be monitored. Fund sponsors should be able to demonstrate the connection
between conflicts and compliance approvals and monitoring. When an employee requests approval to engage
in an outside business activity, we recommend that a fund sponsor’s CCO:
1.

Analyze and Resolve Conflicts of Interest Relating to the Outside Business Activity. First, eachoutside business activity must be analyzed to determine whether it would create any actual or
potential material conflicts of interest with the fund sponsor’s clients. In determining whether aconflict of interest may arise, it is advisable to consider relationships that the outside businessactivity has not just with the fund sponsor’s portfolio companies, but also with those portfolio
companies’ counterparties. Then, each conflict of interest should be analyzed to determine whether
it can be appropriately mitigated through the adoption of tailored policies and procedures and/or bydisclosure to the fund’s board of directors, limited partner advisory committee (to the extentapplicable) or investors. If not, the best course of action may be to prohibit the employee fromengaging in the activity. With respect to disclosure, in the Order, the SEC expressed its view that “[i]tis the client, not the investment adviser, who is entitled to determine whether a conflict of interest
might cause a portfolio manager – consciously or unconsciously – to render advice that is not
disinterested” - so even if a conflict of interest can be mitigated through controls such as tailoredpolicies, disclosure may nonetheless be warranted.

2. Document Analyses and Resolutions of Conflicts of Interest Relating to Outside Business Activities.
The analyses and the manner in which conflicts of interest relating to outside business activities areresolved should be documented.
3. Proactively Monitor Changes in Approved Outside Business Activities. Although policies relating toemployees engaging in permitted outside business activities generally require employees to informthe CCO of any changes in, or material conflicts of interest relating to, such activities, CCOs should
consider taking periodic proactive steps to stay informed. Some methods to proactively monitorchanges include (i) periodically obtaining a certification from the employee that relates to theSimpson Thacher & Bartlett LLP

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specific circumstances of the outside business activities, (ii) interviewing the employee about theoutside business activities and/or (iii) performing additional diligence (e.g. internet searches)
related to outside business activities. The outside business activities and any changes related to themshould be periodically re-evaluated to determine whether, for instance, a change in the outsidebusiness activities has occurred to make a conflict of interest more acute or there has been a change
in the fund sponsor’s business or business relationships that present new conflicts or make anexisting non-material conflict of interest material.
4. Resolve Policy Violations. If a fund sponsor becomes aware that an employee has begun to engage inoutside business activities without prior approval, it should require the employee to cease theoutside business activities until further review is conducted and should consider sanctioning theemployee. We note that, as in the Firm’s situation, outside business activities of employees of private
fund sponsors often involve personal investing. If an employee’s outside business activities involve
investment in a business, the employee may have also violated the fund sponsor’s code of ethics,
which, in accordance with the 1940 Act and the Advisers Act must contain a requirement that certain
employees obtain the fund sponsor’s approval before they acquire beneficial ownership of any
security in a limited offering. 1
5.

Report Conflicts of Interest to Personnel Responsible for Disclosure Documents. If the person(s)responsible for deciding that an outside business activity is permissible are different than thepersonnel responsible for the fund sponsor’s and/or the funds’ disclosure documents (e.g., FormADV, private placement memorandum, prospectus and statement of additional information), theperson(s) who approved the outside activity should ensure that those responsible for disclosure
documents are aware of the approved outside business activity and the conflicts of interest it
presents and work with those individuals to ensure that adequate disclosure, if necessary, is added to
the relevant documents. For registered fund sponsors, in addition to written disclosure obligations,the fund sponsor should have a process in place to consider whether disclosure to the board ofdirectors of the registered fund is also advisable, regardless of whether written disclosure documents
are updated.

The foregoing recommendations are not hard and fast rules and are intended to serve as a guideline toapproaching outside business activities of fund sponsor employees. While the major considerations may be
the same, each circumstance will generally merit a customized approach.

1 See Advisers Act Rule 204A-1(c) and 1940 Act Rule 17j-1(e).

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Please contact Lisa Klar (lisa.klar@stblaw.com; +1-212-455-3635) or the partner in the Private Funds
Group or the Registered Funds Group with whom you work if you have any questions.

The contents of this publication are for informational purposes only. Neither this publication nor the lawyers who authoredit are rendering legal or other professional advice or opinions on specific facts or matters, nor does the distribution of thispublication to any person constitute the establishment of an attorney-client relationship. Simpson Thacher & Bartlett LLP
assumes no liability in connection with the use of this publication. Please contact your relationship partner if we can be ofassistance regarding these important developments. The names and office locations of all of our partners, as well as ourrecent memoranda, can be obtained from our website, www.simpsonthacher.com.

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