Earlier this week the SEC issued a new Risk Alert on adviser due diligence regarding alternative investments. The information provided by the SEC is based upon ten recent examinations of private fund advisers, including hedge funds, private equity funds, and alternative fund of fund advisers.
Generally, the Staff found that advisers have increased their due diligence and oversight of third-party managers and other service providers in recent years. Specifically, portfolio level transparency and the use of SMAs have been on the increase. Transparency is now more open due to the proliferation of third party entities that have built databases that aggregate data and make that data available to the industry for research and comparison. More clients are requesting and advisers are now offering separate accounts as opposed to pooled investment vehicles in order to more closely monitor client assets for liquidity and appropriateness of holdings, fees, and expenses.
As for compliance programs, the Risk Alert highlights the following observations or weaknesses discovered during the reviews:
- Annual reviews that did not include a review of the due diligence process (weakness)
- Weak client disclosures that are either inadequate or inconsistent with fiduciary standards
- Misleading marketing claims regarding a firm’s due diligence process
- Firms with adequate written due diligence policies and procedures were more likely to actually implement a due diligence process on a consistent basis (observation)
- Firms that did not conduct regular oversight of third party service providers were more likely to have service providers that were not meeting their contractual obligations (observation)