A Guide to SEC Enforcement Priorities for Private Funds & Advisers

The SEC has emphasized the importance of disclosing fees and expenses to clients. They have been examining undisclosed compensation, particularly those arising from affiliated service providers. The SEC has highlighted that disclosures must be clear and transparent, avoiding vague language like “may.”

They’ve also scrutinized compensation from portfolio companies to advisers and accelerated monitoring fees, ensuring they are disclosed and aligned with fiduciary duties.

The SEC requires advisers to allocate expenses fairly and proportionately among funds and investors. They have been scrutinizing the misallocation of expenses between funds, advisers, and co-investors. The SEC has emphasized the importance of disclosing expense allocation arrangements and ensuring they are fair and equitable.

They have also highlighted the need for clear and specific disclosures regarding a fund’s obligation to bear the adviser’s operating expenses and the effectiveness of expense allocation procedures.

The SEC requires advisers to accurately calculate fees based on disclosures and use appropriate valuation methodologies.

They have been scrutinizing valuation practices, especially for illiquid assets and emerging asset classes. The SEC has emphasized the importance of robust documentation, reliable processes, and transparency in valuation practices.

They have also focused on management fee calculations, ensuring they are reduced in accordance with fund documents and that investments are written down or written off at appropriate times.

The SEC considers undisclosed loans, investments, and other financial interests as potential conflicts of interest.

They have been scrutinizing adviser-led investments in real estate projects and other principal transactions. The SEC has emphasized the importance of disclosing these conflicts and obtaining written consent from investors, especially for principal transactions.

They have also highlighted that verbal disclosures are not sufficient and that conflicts of interest disclosures in a Form ADV Brochure do not automatically resolve conflicted actions.

The SEC considers undisclosed relationships with third-party service providers as potential conflicts of interest, even if they do not financially harm investors.

They have been scrutinizing advisers who fail to disclose such relationships, emphasizing the importance of transparency and presenting potential conflicts to the Limited Partner Advisory Committee (LPAC).

While the focus on fiduciary failures remains, the prominence of policies, procedures, and practical interactions with investors is increasing. This is evident in areas like Material Non-Public Information “(MNPI”) controls, restructurings, cybersecurity, ESG investing, the Marketing Rule, cryptocurrency, and electronic messaging. Below is an overview of emerging enforcement concerns:

The SEC has increased its scrutiny of private fund compliance professionals, focusing on ensuring they independently verify investment team members’ representations regarding material regulatory risks.

The regulator has highlighted the importance of written policies and procedures to prevent the disclosure of MNPI and ensure compliance professionals are sufficiently inquiring into potential MNPI-related risks.

The SEC is closely examining adviser-led fund restructurings, focusing on valuations used in secondary transactions and other adviser-led transactions. They are also interested in ensuring that investors receive informed consent for such transactions. Their areas of focus also include the timing and completeness of investor communications.

The SEC considers cybersecurity a significant risk due to increased cyberthreats. They are focusing on ensuring firms are complying with new rules requiring advisers to have adequate cybersecurity policies and procedures in place to protect customer data, prevent unauthorized access, and respond to incidents effectively. The SEC expects asset managers to disclose cybersecurity incidents and breaches to relevant parties, even if there is no direct financial harm. Failing to do so can result in enforcement actions and penalties.

The SEC will continue scrutinizing ESG disclosures to identify material misrepresentations.

They have designated resources to assess information across registrants and identify compliance violations related to ESG strategies and statements. The SEC has adopted a final rule to standardize client-related disclosures by public companies and is expected to issue a final ESG rule for investment advisers. Even prior to the adoption of that rule, advisers must comply with the Marketing Rule and the anti-fraud rules in Section 206 with respect to their ESG statements and strategies.

Advisers must also consider evolving state issues, litigation challenges, and investor preferences.

The SEC has continued to focus on the Marketing Rule, particularly regarding the use of hypothetical performance in marketing materials.

They have settled with multiple investment advisers for violating these rules, emphasizing that advertising hypothetical performance to a mass audience requires sufficient information about the audience’s financial situation and investment objectives.

The SEC has also highlighted the importance of maintaining substantiation documents, performance disclosures, and written policies and procedures related to marketing practices.

The SEC has increased its focus on digital assets, including their offers, sales, recommendations, and compliance practices. They have proposed new rules that may impact custody of digital assets and have emphasized the importance of understanding exposure to this asset class.

The SEC has also shown interest in emerging financial technologies, such as AI and trading automation. They have warned against “AI-washing” and are expected to continue monitoring and regulating the use of these technologies in the private fund industry.

The SEC has focused on enforcement actions related to off-channel communications, obtaining nearly US$2 billion in penalties.

They have scrutinized record-keeping practices for electronic communications, emphasizing the importance of maintaining required records securely. Common violations include failure to maintain text and other messages on authorized and unauthorized devices, and failure to monitor and enforce record-keeping policies.

While the SEC has not provided specific guidance on when investment committee documentation may constitute an investment recommendation or advice, maintaining such communications is crucial to avoid regulatory risks.

The SEC’s ongoing enforcement efforts highlight the critical need for comprehensive regulations governing private fund advisers. Despite the recent legal setback, the identified areas of violations, including undisclosed fees, misallocation of expenses, valuation practices, conflicts of interest, and emerging risks, underscore the urgent need for clear and enforceable rules.

The SEC’s whistleblower program was established by Congress to incentivize whistleblowers to report violations of securities law, such as the ones listed above.

The Commission is authorized to provide awards to those whose information leads to sanctions exceeding $1 million. The award can range from 10% and 30% depending on the quality of information, timeliness of reporting, one’s involvement in the violation, among many other factors.

The program also offers protection against retaliation and anonymous whistleblowing to maximize the effectiveness of bringing such violations to light.

Learn more by reading SEC Whistleblower Program: A Guide to Reporting Financial Fraud

Our staff is comprised of veteran whistleblower attorneys, including former SEC Commissioner Allison Herren Lee and former SEC Enforcement Senior Counsel, Andrew Feller. If you’d like to speak with an expert securities fraud attorney regarding a potential violation, get in touch with us today. Your consultation is free, and in many cases, we don’t get paid unless we get results.