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SEC 2015 Examination Priorities: Topics of Greatest Interest to Hedge and Private Equity Funds

Jan.16.2015

On January 13, 2015, the SEC's Office of Compliance Inspections and Examinations (OCIE) published its annual list of examination priorities for investment advisers, broker-dealers and transfer agents. For a copy of the SEC's press release, please see here.

While the 2015 priorities survey a fairly broad range of topics, we focus here on the select few areas that we think are most important to hedge and private equity funds.

Data Analytics to Drive Exams

Data analytics are one of the major themes of the SEC's 2015 examination priorities. It appears to us that the SEC has become much more sophisticated in recent years in its use of data to identify activity that may or may not be legitimate. As a practical matter, when the SEC comes knocking, advisers are not told if the SEC's analytics suggest something is amiss. The OCIE, instead, makes its standard data collection request, crunches the information and, if there is no improper activity, would appear to simply address other issues. We suspect our clients and other friends of the firm may inadvertently draw inquiry because of superior, long-term performance. Difficult though it may be, it is important for advisers to remain focused on business during the stresses of a presence exam. The SEC's data systems are what they are and advisers should have a full opportunity to discuss and explain their perspective to the examiners. 

Fees and Expenses

The 2015 priorities again reference the importance of fees and expenses passed along to limited partners. Ever since OCIE director Andrew Bowden gave a speech in May 2014, wherein he asserted that more than half of all private equity advisers examined by the OCIE have been found to be violating laws or to have material weaknesses with respect to how they assess fees and expenses, private fund sponsors have been on notice that they face particular scrutiny by the SEC. We discussed Mr. Bowden's speech in a recent client alert, which may be found here.

Stories of the market impact of this heightened scrutiny have been covered in the press with some degree of regularity.  Blackstone, for example, has curbed the practice of collecting "monitoring fees" in response to regulatory scrutiny.1 More than a dozen private-equity firms have revised their regulatory filings amid pressure from federal securities regulators, publicly disclosing for the first time some fees and expenses charged to public pension funds and other investing clients.2 Pension plans also have jumped on the regulatory bandwagon in an effort to negotiate lower fees for their private equity investments as well.3

It is somewhat surprising to us that the OCIE has this topic as a top priority, since we find that limited partners, especially major institutional investors and sovereign wealth funds, are typically quite sophisticated and capable of negotiating terms. Editorial comment aside, the industry should take note and prepare accordingly. 

Internal Controls

Internal controls continue to be an area significant concern for the OCIE, and the 2015 priorities highlight four areas of focus for funds. First, the OCIE is focused on policies and procedures relating to leverage, liquidity and valuation. This focus builds upon an October 29, 2014 speech to a SIFMA group by Norm Champ, Director of the SEC's Division of Investment Management.4 Funds should compare the investment strategies described in their disclosure documents against the investment strategies they actually employ and ensure that their disclosure is accurate and complete and in plain English.  Disclosure should also take a holistic view of risks – as Director Champ noted in his SIFMA speech, the SEC staff "generally believes that the risk disclosure in the prospectus for each fund should provide an investor a complete risk profile of the fund's investments taken as a whole, rather than a list of various investment strategies, and reflect anticipated alternative investment or asset usage." Second, the OCIE is focusing on staffing, funding, and empowerment of boards, compliance personnel and back-offices of funds and related policies and procedures. Third, fund marketing continues an OCIE focus. Finally, building on broader areas of SEC and governmental focus and a 2014 focus for the OCIE, the OCIE will review cybersecurity controls and safeguards.   

First-Time Exams

If your business is newly registered, expect to be examined. We strongly encourage clients to conduct internal "mini-examinations" before the SEC calls. Firms should ensure their documents are organized and prepared for immediate production upon demand by the Staff. Firms also should fix any matters identified during the internal review stage, and should ensure that any prior deficiencies are corrected (among other reasons, to avoid recidivism and potential enforcement charges). Consider whether it makes sense to have your law firm retain any third party conducting the review.


1 See Mark Maremont and Mike Spector,  Blackstone to Curb Controversial Fee Practice, The Wall Street Journal, Oct. 7, 2014, available at http://www.wsj.com/articles/blackstone-to-curb-controversial-fee-practice-1412714245.

2 See Mark Maremont and Mike Spector,  Buyout Firms Disclose More Fees, The Wall Street Journal, November 20, 2014, available at http://www.wsj.com/articles/buyout-firms-disclose-more-fees-1416510945.

3 See Simon Clark, Pension Funds Lambaste Private-Equity Fees, The Wall Street Journal, November 21, 2014, available at http://www.wsj.com/articles/pension-funds-lambast-private-equity-firms-for-large-fees-1416562426.

4 See Norm Champ,  Remarks to the SIFMA Complex Products Forum, Oct. 29, 2014, available at http://www.sec.gov/News/Speech/Detail/Speech/1370543319219#.VF5Ej76L1rZ.


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