Key Takeaways
- • SEC's Office of Compliance Inspections and Examinations (OCIE) published a Risk Alert on June 23, 2020, identifying three critical compliance deficiency areas in private fund advisers: conflicts of interest, fees and expenses, and material non-public information (MNPI) policies.
- • Over 36 percent of investment advisers registered with the SEC manage private funds, many of which hold significant capital from pensions, charities, endowments, and family offices—making compliance lapses a systemic concern affecting institutional investors.
- • Common deficiencies have resulted in investors paying excess fees and expenses or failing to receive adequate disclosure of conflicts of interest between private fund advisers and their funds, exposing fiduciary duty violations.
- • The SEC enforcement framework, grounded in Section 206 of the Investment Advisers Act of 1940, prohibits advisers from engaging in fraudulent schemes or deceptive practices with clients, establishing the regulatory baseline for private fund adviser conduct.
- • The Risk Alert serves as a proactive compliance guidance tool, signaling the SEC's intensified examination scrutiny of private fund advisers and flagging systemic issues that may warrant future enforcement actions.
Summary
On June 23, 2020, the Securities and Exchange Commission's Office of Compliance Inspections and Examinations (OCIE) issued a formal Risk Alert addressing compliance deficiencies identified during examinations of registered investment advisers managing private equity and hedge funds. The alert represents a significant regulatory intervention targeting an industry segment managing assets for approximately 36 percent of all SEC-registered investment advisers—a substantial portion of the alternative investment ecosystem.
The Risk Alert identified three primary areas of compliance vulnerability. First, conflicts of interest remain a persistent deficiency, with advisers failing to adequately disclose situations where adviser interests diverge from investor interests. Second, fees and expenses represent a material concern, with OCIE finding instances where investors paid more than disclosed or justified given fund structures and adviser compensation arrangements. Third, policies and procedures governing material non-public information (MNPI) and codes of ethics are frequently inadequate, creating legal and fiduciary exposure under the Investment Advisers Act of 1940.
The implications are material for institutional investors. The alert explicitly notes that private funds held significant capital from pensions, charities, endowments, and family offices—constituencies representing trillions in aggregate assets. Many of the identified deficiencies directly impacted investor returns through excess fees or prevented investors from making fully informed decisions regarding conflicts of interest. This suggests systematic underperformance or opacity across a material segment of the alternative asset management industry.
The SEC's warning is grounded in Section 206 of the Investment Advisers Act, which prohibits advisers from employing fraudulent devices or engaging in deceptive practices with clients. By publishing this Risk Alert, OCIE signaled heightened examination frequency and enforcement prioritization, establishing clear expectations that private fund advisers must enhance compliance infrastructure, strengthen conflict disclosure protocols, and implement robust policies governing compensation and material information handling. The guidance serves both as a compliance roadmap and an implicit warning that adviser deficiencies in these three areas will likely trigger enforcement scrutiny.
The Risk Alert identified three primary areas of compliance vulnerability. First, conflicts of interest remain a persistent deficiency, with advisers failing to adequately disclose situations where adviser interests diverge from investor interests. Second, fees and expenses represent a material concern, with OCIE finding instances where investors paid more than disclosed or justified given fund structures and adviser compensation arrangements. Third, policies and procedures governing material non-public information (MNPI) and codes of ethics are frequently inadequate, creating legal and fiduciary exposure under the Investment Advisers Act of 1940.
The implications are material for institutional investors. The alert explicitly notes that private funds held significant capital from pensions, charities, endowments, and family offices—constituencies representing trillions in aggregate assets. Many of the identified deficiencies directly impacted investor returns through excess fees or prevented investors from making fully informed decisions regarding conflicts of interest. This suggests systematic underperformance or opacity across a material segment of the alternative asset management industry.
The SEC's warning is grounded in Section 206 of the Investment Advisers Act, which prohibits advisers from employing fraudulent devices or engaging in deceptive practices with clients. By publishing this Risk Alert, OCIE signaled heightened examination frequency and enforcement prioritization, establishing clear expectations that private fund advisers must enhance compliance infrastructure, strengthen conflict disclosure protocols, and implement robust policies governing compensation and material information handling. The guidance serves both as a compliance roadmap and an implicit warning that adviser deficiencies in these three areas will likely trigger enforcement scrutiny.
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