SEC Division of Examinations Issues Risk Alert on Private Fund Adviser Examination Observations

February 8, 2022

The staff (“Staff”) of the SEC’s Division of Examinations published a risk alert (“Risk Alert”) on compliance issues observed by the Staff in examinations of registered investment advisers that manage private funds (“private fund advisers”).1 In the Risk Alert, the Staff detailed four areas of private fund adviser examination 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.”

A. Conduct Inconsistent with Disclosures

The Staff 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. The Staff observed private fund advisers that, in contravention of fund disclosures,2 failed to bring conflicts to their LPACs for review and consent, or obtained LPAC consent for certain conflicted transactions after the transaction had occurred or obtained approval after providing the LPAC with incomplete information.
  • Failure to follow practices described in fund disclosures regarding the calculation of Post-Commitment Period fund-level management fees. The Staff observed private fund advisers that failed to 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.
  • Failure to comply with LPA liquidation and fund extension terms. The Staff observed private fund advisers that extended the terms of private equity funds without obtaining the required approvals or complying with the liquidation provisions described in the funds’ LPAs.
  • Failure to invest in accordance with fund disclosures regarding investment strategy and investment limitations. The Staff observed private fund advisers that did not comply with investment limitations in fund disclosures and diverged materially from the investment strategy described in fund disclosures, or caused funds to exceed leverage limitations specified in fund disclosures.
  • Failure to follow fund disclosures relating to recycling practices. “Recycling” refers to a practice by private equity funds to add realized investment proceeds back to the capital commitments of investors. The Staff observed private fund advisers that did not accurately describe the recycling practices utilized by their funds.
  • Failure to follow fund disclosures regarding key adviser personnel. The Staff observed private fund advisers that did not adhere to the LPA “key person” process or provide investors with accurate information regarding the departure of former principals and portfolio managers.

B. Disclosures Regarding Performance and Marketing

  • Misleading material information about a track record. The Staff observed private fund advisers that: (i) provided inaccurate or misleading disclosures about their track record, including how benchmarks were used or how the portfolio for the track record was constructed; (ii) marketed only a favorable or cherry-picked track record of one fund or a subset of funds; (iii) failed to disclose material information about the impact of leverage on fund performance; and (iv) utilized stale performance information in presentations to potential investors or track records that did not accurately reflect fees and expenses.
  • Inaccurate performance calculations. The Staff observed private fund advisers that provided inaccurate and potentially misleading disclosures regarding performance due to the use of inaccurate underlying data, such as 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.
  • Portability – failure to support adequately, or omissions of material information about, predecessor performance. The Staff observed private fund advisers that failed to maintain books and records supporting predecessor performance3 at other advisers as required by Rule 204-2(a)(16) under Investment Advisers Act of 1940 (“Advisers Act”) or 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 private fund adviser were not primarily responsible for achieving.
  • Misleading statements regarding awards or other claims. The Staff observed private fund advisers that failed to make full and fair disclosures regarding awards they received, such as the criteria for obtaining them, the amount of any fee paid by the private fund adviser to receive them, and any amounts paid to the grantor of the awards for the private fund adviser’s right to promote its receipt of the awards.

C. Due Diligence

The Staff emphasized that, consistent with an adviser’s fiduciary duty to have a reasonable belief that the investment advice it provides is in the best interest of a client, the adviser must conduct a reasonable investigation into the investment to ensure that the advice is not based on materially inaccurate or incomplete information. The Staff observed the following issues with respect to private fund advisers’ investment due diligence policies and procedures.

  • Lack of a reasonable investigation into underlying investments or funds. The Staff observed private fund advisers that failed to 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 private fund 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. The Staff observed private fund advisers that outlined a due diligence process in fund disclosures, but failed to maintain tailored policies and procedures related to due diligence of investments.

D. Hedge Clauses

The Staff observed private fund advisers that included potentially misleading “hedge clauses” in documents that purported to waive or limit the adviser’s fiduciary duty under the Advisers Act except in certain instances, such as a non-appealable judicial finding of gross negligence, willful misconduct, or fraud.4  The Staff stated that such clauses could be inconsistent with Sections 206 and 215(a) of the Advisers Act.

S&K Observations

Private fund advisers should carefully examine their practices, policies, procedures, and private fund offering document disclosures in view of the deficiencies identified by the Staff in the Risk Alert.

Seward & Kissel LLP, and our compliance consulting service SKRC (Seward & Kissel Regulatory Compliance), are available to assist advisers with the design, implementation, and review of practices, policies, procedures, and offering document disclosures relating to the issues identified in the Risk Alert.


1 See SEC Division of Examinations Risk Alert, “Observations from Examinations of Investment Advisers Managing Private Funds” (January 27, 2022) available at The Risk Alert adds further observations to those included in the Staff’s prior risk alert on its observations from examinations of private fund advisers. See SEC Division of Examinations Risk Alert, “Observations from Examinations of Investment Advisers Managing Private Funds” (June 23, 2020) available at

2 “Fund disclosures” includes fund limited partnership agreements (“LPAs”), operating agreements, private placement memoranda, due-diligence questionnaires and side letters.

3 The Marketing Rule under the Advisers Act (Rule 206(4)-1) defines “predecessor performance” as investment performance achieved by a group of investments consisting of an account or a private fund that was not advised at all times during the period shown by the investment adviser advertising the performance.

4 The Staff stated that whether a hedge clause in an agreement, or a statement in disclosure documents provided to clients and investors, is misleading and would violate Sections 206 of the Advisers Act depends on all of the surrounding facts and circumstances.