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January 27, 2022 

Observations from Examinations of Private Fund Advisers

I. Introduction

On June 23, 2020, the Division of Examinations (“EXAMS”) published a Risk Alert (the “2020 

Private Fund Adviser Risk Alert”) providing an overview of compliance issues observed by 

EXAMS staff∗ in examinations of registered investment advisers that manage private funds

(“private fund advisers”).

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 In light of the significant role of private fund advisers in the financial 

markets, we are publishing this risk alert detailing additional observations: (A) failure to act 

consistently with disclosures; (B) use of misleading disclosures regarding performance and 

marketing; (C) due diligence failures relating to investments or service providers; and (D) use of 

potentially misleading “hedge clauses.”2

More than 5,000 SEC-registered investment advisers, approximately 35% of all SEC-registered 

advisers, manage approximately $18 trillion in private fund assets.3 In the past five years alone, 

we have observed substantial growth in reported private fund assets, which have increased by 

70% in that period. These assets are deployed through a variety of investment strategies 

employed by hedge funds, private equity funds, and real estate-related funds, among others. The 

size and complexity of advisers vary widely from, for example, an adviser with a private fund 

limited to investors made up of friends and family, to an adviser with a worldwide footprint 

managing multiple private funds with hundreds of billions of dollars in assets. 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. 

II. Legal Background

An investment adviser’s fiduciary duty under the Investment Advisers Act of 1940 (“Advisers 

 ∗ This Risk Alert represents the views of the staff of EXAMS. 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, like all staff statements, 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 EXAMS staff and is not legal advice.

1 EXAMS Risk Alert, Observations from Examinations of Investment Advisers Managing Private Funds (June 

23, 2020) (the “2020 Private Fund Adviser Risk Alert”).

2 The observations in this Risk Alert and the 2020 Private Fund Adviser Risk Alert were drawn from over 5 years 

of examinations of private fund advisers. This Risk Alert, the 2020 Private Fund Adviser Risk Alert, and The 

Five Most Frequent Compliance Topics (Feb. 17, 2017) (for all advisers) reflect observations of the EXAMS 

staff regarding private fund advisers and are intended to assist private fund adviser compliance staff.

3 Form ADV data current as of November 30, 2021.
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Act”) comprises a duty of care and a duty of loyalty.4 This means the adviser must, at all times, 

serve the best interest of its client and not subordinate its client’s interest to its own. In other 

words, the investment adviser cannot place its own interests ahead of the interests of its client. 

This combination of care and loyalty obligations requires the investment adviser to act in the 

“best interest” of its client at all times. Although investment advisers owe their clients a 

fiduciary duty under the Advisers Act, that fiduciary duty must be viewed in the context of the 

agreed-upon scope of the relationship between the adviser and the client.5

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. 

Advisers Act Rule 206(4)-7 (the “Compliance Rule”) requires registered investment advisers to 

adopt and implement written policies and procedures reasonably designed to prevent violations 

of the Advisers Act and the rules that the Commission has adopted under the Advisers Act by the 

adviser or any of its supervised persons. In developing its policies and procedures, an adviser 

should identify matters that create risk exposure for the adviser and its clients in light of the 

firm's particular operations and then design compliance policies and procedures that address 

those risks. The Compliance Rule also requires advisers to review, no less frequently than 

annually, the adequacy of the policies and procedures established and the effectiveness of their 

implementation.

III. Private Fund Adviser Deficiencies6

A. Conduct Inconsistent with Disclosures

EXAMS staff has observed the following failures to act consistently with material disclosures to

clients or investors:

• Failure to obtain informed consent from Limited Partner Advisory Committees, Advisory 

Boards or Advisory Committees (collectively “LPACs”) required under fund disclosures. 

EXAMS staff observed private fund advisers that did not follow practices described in 

their limited partnership agreements (“LPAs”), operating agreements, private placement 

memoranda, due-diligence questionnaires, side letters or other disclosures (“fund 

disclosures”) regarding the use of LPACs. For example, staff observed private fund 

advisers that failed to bring conflicts to their LPACs for review and consent, in 

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 See Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Advisers Act Release 

No. 5248 (June 5, 2019) (“Fiduciary Interpretation”).

5 See Fiduciary Interpretation.

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 This Risk Alert does not address all deficiencies among private fund advisers. In addition to the 2020 Private 

Fund Adviser Risk Alert, EXAMS also published, for example, a risk alert on February 7, 2017, The Five Most 

Frequent Compliance Topics Identified in OCIE Examinations of Investment Advisers, which identifies

deficiencies across all types of investment advisers.
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contravention of fund disclosures. EXAMS staff also observed private fund advisers that 

did not obtain consent for certain conflicted transactions from the LPAC until after the 

transaction had occurred or obtained approval after providing the LPAC with incomplete 

information in contravention of fund disclosures.

• Failure to follow practices described in fund disclosures regarding the calculation of 

Post-Commitment Period fund-level management fees. EXAMS staff observed private 

fund advisers that did not follow practices described in fund disclosures regarding the 

calculation of the fund-level management fee during a private fund’s Post-Commitment 

Period.7 EXAMS staff observed that such failures resulted in investors paying more in 

management fees than they were required to pay under the terms of the fund disclosures. 

For example, private fund advisers did not reduce the cost basis of an investment when 

calculating their management fee after selling, writing off, writing down or otherwise 

disposing of a portion of an investment. Other private fund advisers used broad, 

undefined terms in the LPA, such as “impaired,” “permanently impaired,” “written 

down,” or “permanently written down,” but did not implement policies and procedures 

reasonably designed to apply these terms consistently when calculating management fees, 

potentially resulting in inaccurate management fees being charged.

• Failure to comply with LPA liquidation and fund extension terms. EXAMS staff

observed advisers that extended the terms of private equity funds without obtaining the 

required approvals or without complying with the liquidation provisions described in the 

funds’ LPAs, which, among other things, resulted in potentially inappropriate 

management fees being charged to investors. 

• Failure to invest in accordance with fund disclosures regarding investment strategy. 

EXAMS staff observed private fund advisers that did not comply with investment 

limitations in fund disclosures. For example, the staff observed private fund advisers that 

implemented an investment strategy that diverged materially from fund disclosures. 

EXAMS staff also observed advisers that caused funds to exceed leverage limitations

detailed in fund disclosures. 

• Failures relating to recycling practices. “Recycling” refers to contractual provisions that 

allow a fund to add realized investment proceeds back to the capital commitments of 

investors. EXAMS staff observed private fund advisers that did not accurately describe 

the “recycling” practices utilized by their funds or omitted material information from 

such disclosures. In some instances, this failure may have caused private fund advisers to 

collect excess management fees.

• Failure to follow fund disclosures regarding adviser personnel. EXAMS staff observed 

advisers that did not adhere to the LPA “key person” process after the departure of 

 7 Advisers to private equity funds typically assess a management fee based on a percentage of limited partner 

capital commitments during the period of time the fund deploys capital (“Commitment Period”). The basis of 

the amount used to calculate this fee, however, is generally reduced to “invested capital,” less dispositions, 

write downs and write offs after the Commitment Period (“Post-Commitment Period”). These arrangements 

vary in accordance with contractual provisions.
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several adviser principals or did not provide accurate information to investors reflecting

the status of key previously-employed portfolio managers. 

B. Disclosures Regarding Performance and Marketing

EXAMS staff has observed private fund advisers providing to investors or prospective investors 

misleading track records or other marketing statements that appear to violate Rule 206(4)-8.8

 In 

addition, Advisers Act Rule 204-2(a)(16) requires advisers to maintain all accounts, books, 

internal working papers, and any other records or documents that are necessary to form the basis 

for or demonstrate the calculation of any performance or rate of return of any or all managed 

accounts or securities recommendations. EXAMS staff has also observed failures by private 

fund advisers to maintain these required records. 

• Misleading material information about a track record. EXAMS staff observed private 

fund advisers that provided inaccurate or misleading disclosures about their track record, 

including how benchmarks were used or how the portfolio for the track record was 

constructed. For example, the staff observed advisers that only marketed a favorable or 

cherry-picked track record of one fund or a subset of funds or did not disclose material 

information about the material impact of leverage on fund performance. In addition, the 

staff observed private fund advisers that utilized stale performance information in 

presentations to potential investors or track records that did not accurately reflect fees and 

expenses. 

• Inaccurate performance calculations. EXAMS staff observed private fund advisers that 

presented inaccurate performance calculations to investors. For example, the staff 

observed private fund advisers that used inaccurate underlying data (e.g., data from 

incorrect time periods, mischaracterization of return of capital distributions as dividends 

from portfolio companies, and/or projected rather than actual performance used in 

performance calculations) when creating track records, thereby leading to inaccurate and 

potentially misleading disclosures regarding performance. 

• Portability - failure to support adequately, or omissions of material information about,

predecessor performance. EXAMS staff observed private fund advisers that did not 

maintain books and records supporting predecessor performance at other advisers as 

required under Advisers Act Rule 204-2(a)(16). In addition, the staff observed private 

fund advisers that appeared to have omitted material facts about predecessor 

performance. For example, the staff observed private fund advisers that marketed 

incomplete prior track records or advertised performance that persons at the adviser were 

not primarily responsible for achieving at the prior adviser. 

• Misleading statements regarding awards or other claims. EXAMS staff observed private 

fund advisers that made misleading statements regarding awards they received or 

characteristics of their firm. For example, the staff observed private fund advisers that 

 8 The Commission adopted significant revisions to Advisers Act Rule 206(4)-1 that address the marketing of 

private funds. The rule, which advisers must comply with by November 4, 2022, provides additional specificity 

regarding misleading marketing materials. In addition to Rule 206(4)-1 and Rule 206(4)-8, the anti-fraud 

provisions of the federal securities laws, e.g., Section 206 of the Advisers Act, Section 17(a) of the Securities 

Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934, may apply to this activity. 
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marketed awards received, but failed to make full and fair disclosures about the awards, 

such as the criteria for obtaining them, the amount of any fee paid by the adviser to 

receive them, and any amounts paid to the grantor of the awards for the adviser’s right to 

promote its receipt of the awards. The staff also observed advisers that incorrectly 

claimed their investments were “supported” or “overseen” by the SEC or the United 

States government. 

C. Due Diligence

As a fiduciary, an investment adviser must have a reasonable belief that the advice it provides is 

in the best interest of the client based on the client’s objectives. A reasonable belief that 

investment advice is in the best interest of a client also requires that an adviser conduct a 

reasonable investigation into the investment that is sufficient to ensure that the adviser is not 

basing its advice on materially inaccurate or incomplete information.9

EXAMS staff observed potential failures to conduct a reasonable investigation into an 

investment, to follow the due diligence process described to clients or investors, and to adopt and 

implement reasonably designed due diligence policies and procedures pursuant to the 

Compliance Rule:

• Lack of a reasonable investigation into underlying investments or funds. EXAMS staff 

observed advisers that did not perform reasonable investigations of investments in 

accordance with their policies and procedures, including the compliance and internal 

controls of the underlying investments or private funds in which they invested. In 

addition, the staff observed advisers that failed to perform adequate due diligence on 

important service providers, such as alternative data providers and placement agents. 

• Inadequate policies and procedures regarding investment due diligence. EXAMS staff

observed private fund advisers that did not appear to maintain reasonably designed

policies and procedures regarding due diligence of investments. For example, the staff 

observed private fund advisers that outlined a due diligence process in fund disclosures, 

but did not maintain policies and procedures related to due diligence that were tailored to 

their advisory businesses.

D. Hedge Clauses

Whether a clause in an agreement, or a statement in disclosure documents provided to clients and 

investors, that purports to limit an adviser’s liability (a “hedge clause”) is misleading and would 

violate Sections 206(1) and 206(2) of the Advisers Act depends on all of the surrounding facts 

and circumstances.10 EXAMS staff observed private fund advisers that included potentially 

misleading hedge clauses in documents that purported to waive or limit the Advisers Act 

fiduciary duty except for certain exceptions, such as a non-appealable judicial finding of gross 

negligence, willful misconduct, or fraud. Such clauses could be inconsistent with Sections 206 

and 215(a) of the Advisers Act.

 9 See Fiduciary Interpretation.

10 See Fiduciary Interpretation.
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IV. Conclusion

Examinations of private fund advisers have resulted in a range of actions, including 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 

EXAMS staff. The Division encourages private fund advisers to review their practices, and

written policies and procedures, including implementation of those policies and procedures, to 

address the issues identified in this Risk Alert.

This Risk Alert is intended to highlight for firms risks and issues that EXAMS 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.