The SEC continues to pursue enforcement actions against hedge fund managers for alleged self-dealing, undisclosed conflicts of interest, and valuation issues. As we’ve previously reported (here and here), the SEC has stepped up its review and enforcement of private fund managers following Dodd-Frank, which required most investment advisers to private funds to register with the SEC, which in turn subjected them to increased regulatory oversight.
As previously detailed, the SEC has been publicly counseling fund advisers that its Office of Compliance Inspections and Examination (OCIE) would ramp up examinations of advisers and would focus particularly on certain issues of concern it had identified within the private fund industry, such as marketing practices, portfolio management, conflicts of interest, safety of client assets, and valuation.
As expected, this increased focus has led to SEC enforcement actions against private fund advisers related to these same issues, including a couple of new actions this past month. In early September, the SEC announced it settled an action with an investment adviser and its CEO, accused by the SEC of inflating the value of fund portfolio assets to generate unearned management fees. Among other issues, the CEO allegedly falsely claimed the fund owned an asset, when in reality, it owned a different asset worth substantially less. The SEC obtained over $1 million in combined disgorgement, interest and penalties, and the CEO agreed to be barred from the industry. In the same press release, the SEC announced it had settled an administrative proceeding with the fund’s outside auditors. The SEC alleged that the auditors did not adhere to generally accepted auditing standards and performed a deficient audit, wherein they failed to obtain sufficient appropriate audit evidence regarding whether certain fund assets existed. The auditors have been suspended for three years from practicing as accountants on behalf of any publicly traded company or SEC-regulated entity.
And just last week, the SEC charged a registered investment adviser and its owner with securities fraud (and with violating, or aiding and abetting violations of, other SEC rules) related to its management of affiliated hedge funds and clients of those funds. As explained in the SEC’s press release announcing the charges, the SEC alleged that the adviser (and its owner) engaged in self-dealing and failed to disclose conflicts of interest or material facts about use of investor funds and investment risk. For example, the adviser allegedly caused affiliated hedge funds to invest in companies without disclosing its financial interests in those companies. This case reflects yet another example of the SEC Enforcement Division pursuing the same potential problems − such as conflicts of interest and portfolio management − that have been publicly identified as priority issues by OCIE and the National Examination Program.
This enforcement trend is likely to continue. As more newly registered advisers are inspected, the odds are good that the SEC will identify additional problems and pursue more enforcement actions related to valuation issues, conflicts of interest, and other focal issues of OCIE examinations. Therefore, private fund advisers need to ensure they have robust compliance programs tailored to the particulars of their individual businesses and that they review and update them often. Otherwise, it might not be just OCIE that comes knocking.