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June 23, 2020

Observations from Examinations of Investment Advisers Managing Private Funds

I. Introduction

This Risk Alert provides an overview of certain compliance issues observed by the Office of 

Compliance Inspections and Examinations (“OCIE”)∗ in examinations of registered investment 

advisers that manage private equity funds or hedge funds (collectively, “private fund advisers”). 

Over 36 percent of investment advisers registered with the Commission manage private funds, 

which frequently have significant investments from pensions, charities, endowments, and 

families. OCIE examines hundreds of private fund advisers each year and is frequently asked 

about its observations from these examinations as well as common deficiencies and compliance 

issues. Many of the deficiencies discussed below may have caused investors in private funds

(“investors”) 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. 

This Risk Alert is intended to assist private fund advisers in reviewing and enhancing their 

compliance programs, and also to provide investors with information concerning private fund 

adviser deficiencies.

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II. Private Fund Adviser Deficiencies2

This Risk Alert discusses three general areas of deficiencies that OCIE has identified in 

examinations of private fund advisers: (A) conflicts of interest, (B) fees and expenses, and 

(C) policies and procedures relating to material non-public information (“MNPI”). 

A. Conflicts of Interest 

Section 206 of the Investment Advisers Act of 1940 (“Advisers Act”) prohibits investment 

advisers from employing any device, scheme, or artifice to defraud any client or prospective 

client, and from engaging in any transaction, practice, or course of business which operates as a 

 ∗ The views expressed herein are those of the staff of OCIE. This Risk Alert is not a rule, regulation, or statement 

of the Securities and Exchange Commission (the “SEC” or the “Commission”). The Commission has neither 

approved nor disapproved the content of this Risk Alert. This Risk Alert has no legal force or effect: it does not 

alter or amend applicable law, and it creates no new or additional obligations for any person. This document 

was prepared by OCIE staff and is not legal advice.

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 Examinations of private fund advisers do not all result in OCIE issuing a deficiency letter. The Commission has 

brought Enforcement actions on a number of the issues discussed in this Risk Alert. OCIE continues to observe 

some of these practices during examinations. 

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 This Risk Alert does not address all deficiencies among private fund advisers. OCIE published a risk alert on 

February 7, 2017, The Five Most Frequent Compliance Topics Identified in OCIE Examinations of Investment 

Advisers, which identifies the most common deficiencies across all types of investment advisers.
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fraud or deceit upon any client or prospective client. An investment adviser must eliminate or 

make full and fair disclosure of all conflicts of interest which might incline an investment adviser 

– consciously or unconsciously – to render advice which is not disinterested such that a client 

can provide informed consent to the conflict. In order for disclosure to be full and fair, it should 

be sufficiently specific so that a client is able to understand the material fact or conflict of 

interest and make an informed decision whether to provide consent.3

In addition, Advisers Act Rule 206(4)-8 prohibits investment advisers to pooled investment 

vehicles from (1) making any untrue statement of a material fact or omitting to state a material 

fact necessary to make the statements made, in the light of the circumstances under which they 

were made, not misleading, to any investor or prospective investor in the pooled investment 

vehicle; or (2) otherwise engaging in any act, practice, or course of business that is fraudulent, 

deceptive, or manipulative with respect to any investor or prospective investor in the pooled 

investment vehicle. 

OCIE staff has observed the following conflicts of interest that appear to be inadequately 

disclosed and deficiencies under Section 206 or Rule 206(4)-8:

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• Conflicts related to allocations of investments. The staff observed private fund advisers that 

did not provide adequate disclosure about conflicts relating to allocations of investments 

among clients, including the adviser’s largest private fund clients (“flagship funds”), private 

funds that invest alongside flagship funds in the same investments (“coinvestment vehicles”), 

sub-advised mutual funds, collateralized loan obligation funds, and separately managed 

accounts (“SMAs”) (together, “clients”). For example:

o The staff observed private fund advisers that preferentially allocated limited investment 

opportunities to new clients, higher fee-paying clients, or proprietary accounts or 

proprietary-controlled clients, thereby depriving certain investors of limited investment

opportunities without adequate disclosure.

o The staff observed private fund advisers that allocated securities at different prices or in 

apparently inequitable amounts among clients (1) without providing adequate disclosure

about the allocation process or (2) in a manner inconsistent with the allocation process 

disclosed to investors, thereby causing certain investors to pay more for investments or 

not to receive their equitable allocation of such investments.

• Conflicts related to multiple clients investing in the same portfolio company. The staff 

observed private fund advisers that did not provide adequate disclosure about conflicts 

created by causing clients to invest at different levels of a capital structure, such as one client 

owning debt and another client owning equity in a single portfolio company, thereby 

 3 The Advisers Act imposes a fiduciary duty on investment advisers, which includes both a duty of care and a 

duty of loyalty. The duty of loyalty requires that an adviser not subordinate its clients’ interests to its own. In 

other words, an investment adviser must not place its own interest ahead of its client’s interests. To meet its 

duty of loyalty, an adviser must make full and fair disclosure to its clients of all material facts relating to the 

advisory relationship. See Commission Interpretation Regarding Standard of Conduct for Investment Advisers, 

Advisers Act Release No. IA-5248 (June 5, 2019). 

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 This Risk Alert uses phrases such as “adequate disclosure” or “adequate information” when referencing a 

private fund adviser’s disclosure obligations.
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depriving investors of important information related to conflicts associated with their 

investments.

• Conflicts related to financial relationships between investors or clients and the adviser. The

staff observed private fund advisers that did not provide adequate disclosure about economic 

relationships between themselves and select investors or clients. In some cases, these 

investors acted as initial investors in the adviser’s private funds (also known as “seed 

investors”). In other situations, these select investors - for example, having provided credit 

facilities or other financing to the adviser or the adviser’s private fund clients - had economic 

interests in the adviser. Failure to provide adequate disclosure about these arrangements

meant that other investors did not have important information related to conflicts associated 

with their investments.

• Conflicts related to preferential liquidity rights. The staff observed private fund advisers that 

entered into agreements with select investors (“side letters”) that established special terms, 

including preferential liquidity terms, but did not provide adequate disclosure about these 

side letters. As a result, some investors were unaware of the potential harm that could be 

caused if the selected investors exercised the special terms granted by the side letters. 

Similarly, the staff observed private fund advisers that set up undisclosed side-by-side 

vehicles or SMAs that invested alongside the flagship fund, but had preferential liquidity 

terms. Failure to disclose these special terms adequately meant that some investors were 

unaware of the potential harm that could be caused by selected investors redeeming their 

investments ahead of other investors, particularly in times of market dislocation where there

is a greater likelihood of a financial impact.

• Conflicts related to private fund adviser interests in recommended investments. The staff 

observed private fund advisers that had interests in investments recommended to clients, but 

did not provide adequate disclosure of such conflicts. In some instances, adviser principals 

and employees had undisclosed preexisting ownership interests or other financial interests, 

such as referral fees or stock options in the investments.

• Conflicts related to coinvestments. The staff observed inadequately disclosed conflicts 

related to investments made by coinvestment vehicles and other coinvestors, potentially 

misleading certain investors as to how these coinvestments operate. For example, the staff 

observed private fund advisers that disclosed a process for allocating coinvestment 

opportunities among select investors, or among coinvestment vehicles and flagship funds, but 

failed to follow the disclosed process. The staff also observed private fund advisers that had 

agreements with certain investors to provide coinvestment opportunities to those investors, 

but did not provide adequate disclosure about the arrangements to other investors. This lack 

of adequate disclosure may have caused investors to not understand the scale of 

coinvestments and in what manner coinvestment opportunities would be allocated among 

investors.

• Conflicts related to service providers. The staff observed inadequately disclosed conflicts 

related to service providers and private fund advisers. For example, portfolio companies 

controlled by advisers’ private fund clients entered into service agreements with entities 

controlled by the adviser, its affiliates, or family members of principals without adequately 

disclosing the conflicts. The staff also observed advisers that had other financial incentives 
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for portfolio companies to use certain service providers, such as incentive payments from 

discount programs, but failed to disclose the incentives and conflicts to investors adequately. 

o The staff also observed private fund advisers that did not have in place procedures to 

ensure that they followed their disclosures related to affiliated service providers. 

Advisers represented to investors that services provided to the private funds or portfolio 

companies by affiliates would be provided on terms no less favorable than those that 

could be obtained from unaffiliated third parties. However, the advisers did not have 

procedures or support to establish whether comparable services could be obtained from 

an unaffiliated third party on better terms, including at a lower cost.

• Conflicts related to fund restructurings.5 The staff observed private fund advisers that 

inadequately disclosed conflicts related to fund restructurings and “stapled secondary 

transactions.”6 For example:

o Advisers purchased fund interests from investors at discounts during restructurings 

without adequate disclosure regarding the value of the fund interests. The staff also 

observed advisers that did not provide adequate disclosure about investor options during 

restructurings, potentially impacting the decisions made by investors.

o Advisers did not provide adequate information in communications with investors about 

fund restructurings. The staff observed advisers that required any potential purchaser of 

investor interests to agree to a stapled secondary transaction or provide other economic 

benefits to the adviser without adequate disclosure about the conflict to investors.

• Conflicts related to cross-transactions. The staff observed private fund advisers that

inadequately disclosed conflicts related to purchases and sales between clients, or crosstransactions. For example, advisers established the price at which securities would be 

transferred between client accounts in a way that disadvantaged either the selling or 

purchasing client but without providing adequate disclosure to its clients.

B. Fees and Expenses

OCIE staff observed the following fee and expense issues that appear to be deficiencies under 

Section 206 or Rule 206(4)-8:

• Allocation of fees and expenses. The staff observed private fund advisers that have 

inaccurately allocated fees and expenses. For example:

o Advisers allocated shared expenses, such as broken-deal, due diligence, annual meeting, 

consultants, and insurance costs, among the adviser and its clients, including private fund 

clients, employee funds, and coinvestment vehicles, in a manner that was inconsistent 

 5 Fund restructurings are transactions where a private fund adviser arranges the sale of an existing private fund or 

the fund’s portfolio to a purchaser. In a restructuring, the purchaser often offers the existing investors the 

option to sell their interests or roll their interests into a new, restructured private fund. 

6 A “stapled secondary transaction” combines the purchase of a private fund portfolio with an agreement by the 

purchaser to commit capital to the adviser’s future private fund.
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with disclosures to investors or policies and procedures, thereby causing certain investors

to overpay expenses.

o Advisers charged private fund clients for expenses that were not permitted by the relevant 

fund operating agreements, such as adviser-related expenses like salaries of adviser 

personnel, compliance, regulatory filings, and office expenses, thereby causing investors 

to overpay expenses.

o Advisers failed to comply with contractual limits on certain expenses that could be 

charged to investors, such as legal fees or placement agent fees, thereby causing investors 

to overpay expenses.

o Advisers failed to follow their own travel and entertainment expense policies, potentially 

resulting in investors overpaying for such expenses.

• “Operating partners.” The staff observed private fund advisers that did not provide 

adequate disclosure regarding the role and compensation of individuals that may provide 

services to the private fund or portfolio companies, but are not adviser employees (known as 

“operating partners”), potentially misleading investors about who would bear the costs 

associated with these operating partners’ services and potentially causing investors to 

overpay expenses.

• Valuation. The staff observed private fund advisers that did not value client assets in 

accordance with their valuation processes or in accordance with disclosures to clients (such 

as that the assets would be valued in accordance with GAAP). In some cases, the staff 

observed that this failure to value a private fund’s holdings in accordance with the disclosed 

valuation process led to overcharging management fees and carried interest because such fees 

were based on inappropriately overvalued holdings.

• Monitoring / board / deal fees and fee offsets. The staff observed private fund advisers that 

had issues with respect to the receipt of fees from portfolio companies, such as monitoring 

fees, board fees, or deal fees (collectively “portfolio company fees”). For example:

o Advisers failed to apply or calculate management fee offsets in accordance with 

disclosures and therefore caused investors to overpay management fees. In some 

instances, advisers incorrectly allocated portfolio company fees across fund clients, 

including private fund clients that paid no management fees. The staff also observed 

advisers that failed to offset portfolio company fees paid to an affiliate of the adviser that 

were required to be offset against management fees.

o Advisers disclosed management fee offsets, but did not have adequate policies and 

procedures to track the receipt of portfolio company fees, including compensation that 

their operating professionals may have received from portfolio companies, potentially 

causing investors to overpay management fees.

o Advisers negotiated long-term monitoring agreements with portfolio companies they 

controlled and then accelerated the related monitoring fees upon the sale of the portfolio 

company, without adequate disclosure of the arrangement to investors.
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C. MNPI / Code of Ethics

Section 204A of the Advisers Act (“Section 204A”) requires investment advisers to establish, 

maintain, and enforce written policies and procedures reasonably designed to prevent the misuse 

of MNPI by the adviser or any of its associated persons. Advisers Act Rule 204A-1 (“Code of 

Ethics Rule”) requires a registered investment adviser to adopt and maintain a code of ethics, 

which must set forth standards of conduct expected of advisory personnel and address conflicts 

that arise from personal trading by advisory personnel.

OCIE staff observed the following issues that appear to be deficiencies under Section 204A or

the Code of Ethics Rule:

• Section 204A. The staff observed private fund advisers that failed to establish, maintain, and 

enforce written policies and procedures reasonably designed to prevent the misuse of MNPI 

as required by Section 204A. For example: 

o Advisers did not address risks posed by their employees interacting with: (1) insiders of 

publicly-traded companies, (2) outside consultants arranged by “expert network” firms, 

or (3) “value added investors” (e.g., corporate executives or financial professional 

investors that have information about investments) in order to assess whether MNPI 

could have been exchanged. The staff also observed private fund advisers that did not 

enforce policies and procedures addressing these risks. 

o Advisers did not address risks posed by their employees who could obtain MNPI through 

their ability to access office space or systems of the adviser or its affiliates that possessed 

MNPI. 

o 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.

• Code of Ethics Rule. The staff observed private fund advisers that failed to establish, 

maintain, and enforce provisions in their code of ethics reasonably designed to prevent the 

misuse of MNPI. For example: 

o Advisers did not enforce trading restrictions on securities that had been placed on the 

adviser’s “restricted list.” The staff also observed advisers that had codes of ethics that 

provided for the use of restricted lists, but did not have defined policies and procedures 

for adding securities to, or removing securities from, such lists. 

o Advisers that failed to enforce requirements in their code of ethics relating to employees’ 

receipt of gifts and entertainment from third parties. 

o Advisers that failed to require access persons to submit transactions and holdings reports 

timely or to submit certain personal securities transactions for preclearance as required by 

their policies or the Code of Ethics Rule, as applicable. The staff also observed advisers

that failed to identify correctly certain individuals as “access persons” under their code of 

ethics for purposes of reviewing personal securities transactions. 
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III. Conclusion

OCIE examinations of private fund advisers have resulted in a range of actions, including nocomment letters, deficiency letters and, where appropriate, referrals to the Division of 

Enforcement. In response to these observations, many of the advisers modified their practices to 

address the issues identified by OCIE staff. OCIE encourages private fund advisers to review 

their practices, and written policies and procedures, including implementation of those policies 

and procedures, to address the issues discussed in this Risk Alert.

This Risk Alert is intended to highlight for firms risks and issues that OCIE staff has identified. In 

addition, this Risk Alert describes risks that firms may consider to (i) assess their supervisory, compliance, 

and/or other risk management systems related to these risks, and (ii) make any changes, as may be 

appropriate, to address or strengthen such systems. Other risks besides those described in this Risk Alert 

may be appropriate to consider, and some issues discussed in this Risk Alert may not be relevant to a 

particular firm’s business. The adequacy of supervisory, compliance and other risk management systems 

can be determined only with reference to the profile of each specific firm and other facts and 

circumstances.