2017 – The Year of SEC Exams

About our Contributors
ICS Group is a regulatory compliance consulting firm specializing in providing compliance support to the financial services and insurance industries. We help our clients comply with regulatory requirements and industry standards. Our clients include: registered investment advisers, private equity funds, hedge funds, mutual funds, broker-dealers, insurance companies and state pension plans. Our team of highly experienced compliance professionals know from first-hand experience what regulators are looking for, the industry standards that apply, and how to develop and implement cost-effective business-oriented solutions.

Now that the holidays are behind us and we look forward to a promising new year, I find myself marveling at the year we had and proud of the results we achieved. We were busy on-boarding many new clients and continuing to manage and update the compliance programs for our existing clients. Meanwhile, the OCIE was busy trying to meet its goal of examining 40% of all registered investment advisors. Almost 30% of ICSGroup’s private equity clients were subjected to SEC exams in 2017. It was an extremely busy year. Through these exams we gained a wealth of information about what we’re doing well and how we can use the exam process to inform the compliance guidance we provide to all our clients. Our marketing campaign in 2017 asked, “If the SEC showed up today, would you be ready?” Our clients already knew the answer to this anxiety causing question but I’m sure it was nice to have it confirmed.

The SEC examiners were focused on many different areas, but several seemed to be of particular interest in each of the exams. Here are some of our learnings from examinations of advisors to private equity funds as well as some specific SEC document requests related to each topic.

Sales Practices. The examiners’ focus ranged from marketing materials, the use of third-party placement agents to sales meetings with either consultants or investors. Marketing materials have been the source of many deficiencies in recent years, so much so that the SEC issued a Risk Alert in September 2017 highlighting the most common deficiencies related to marketing materials. Among other things, the examiners challenged performance calculation methodology (as advertised in marketing materials), inquired as to how investors and prospective investors were identified, verified the accuracy of information contained in marketing materials and that they were reviewed, and made it clear that testimonials by portfolio company management were biased statements prohibited by the testimonial rule.

SEC document requests related to sales practices included:

  1. A log of all presentations provided to existing or prospective investors during the Examination Period that contains the following data-points:
    • Title of presentation with name(s) of preparer and reviewer;
    • Approximate date distributed;
    • General description of the recipient or recipient group; and
    • Whether the piece was presented in a one-on-one meeting.
  2. Marketing, advertising, fundraising and investor reporting in connection with marketing or fundraising and investor or client reporting during the Examination Period, the most recent version(s) of the following:
    • General firm presentation;
    • Product-specific presentation for each product-type and strategy within each product_ type;
    • Client quarterly letter (or equivalent);
    • Submitted, comprehensive RFP/DDQ response to prospective investor or to an existing investor; and
    • Annual meeting materials provided to investors (include for all meetings held during the Examination Period).
  3. A list of all completed RFPs provided to prospective investors or consultants.
  4. A list of all third-party consultants for whom the Adviser completed questionnaires or otherwise corresponded with during the Examination Period.
  5. A list of all third-party consultants to whose clients the Adviser made a presentation in an effort to obtain or retain such entity as an advisory client.

Outside Business Activities.

The SEC has determined that outside business activities (OBAs) are a frequent source of conflicts of interest. Whether it be a small ownership interest in a privately held company or a member of the board of a company, the OBA must be disclosed to the CCO and potentially disclosed in the Form ADV. The examiners made clear that volunteer board positions for not-for-profit organizations can also lead to potential conflicts and should be disclosed as well. Take for example a not-for-profit or university that has an endowment. The directors would be in a position to influence the selection of the investment advisor.

An SEC document request related to outside business activities included:

  1. A list of names of public and private companies for which employees of the Adviser or its related persons serve as officers, on the board of directors, or creditors’ committees. For the past 3 years, please detail the employee name, the position(s) held, the relevant company, and the dates such position(s) were held. Please indicate whether there have been any client or access person transactions in any such company.

Fees and Expenses.
The OCIE has continued its focus on fees and expenses charged to an advisor’s fund(s) or portfolio companies. Primary concerns focused on fee arrangements (fee caps or fee waivers) contained in side letters requiring an adjustment to fees charged to certain investors and how those fee adjustments/allocations were handled, whether fees charged were consistent with the language in the LPA, and whether the LPA is sufficient clear and transparent. An example is an LPA that provided that consultant fees would be charged to the fund. “Consultant” could have referred to an industry consultant, a compliance consultant or a 1099 consultant. As some of these consultant fees were not chargeable to the fund while others were, the language was deemed to lack transparency.

An SEC document request related to fees and expenses included:

  1. In Excel, a schedule of each expense/fee recovered by the Adviser (or any of the Adviser’s related persons) from/for the funds during the past 3 years. Include the following information:
    • Fund vehicle name;
    • Date received;
    • Amount;
    • Type of fee/expense;
    • If a fee is shared between the fund and the Adviser (or any of the Adviser’s related persons), provide the allocation methodology used;
    • If an expense is shared across funds, provide the allocation methodology used and the frequency with which such methodology is reviewed;
    • A description of the services provided; and
    • Whether the fee or expense reimbursement was offset either partially or entirely by other revenue.
  2. A detailed breakdown of organizational expenses for each fund organized in the previous 5-year period to the extent that those expenses were borne by the funds rather than the Adviser.
  3. In Excel, copies of any financial records, including cash receipts/cash disbursements journal(s), which would reflect the schedule of payments of all expenses by the private funds, related General Partners, and special purpose vehicles and/or other entities established for investment purposes. Provide any supporting documentation that demonstrates how any shared expenses were allocated among the private funds, the Adviser, and other entities.

Whistleblower Policies.
The SEC is committed to ensuring that registered investment advisors comply with its guidance related to its Whistleblower Program. Though not technically law, the examiners are enforcing their “requirement” that registered investment advisors’ compliance manuals contain a Whistleblower Policy. The Policy must also expressly encourage employees to report suspected violations directly to the SEC. Advisors whose policies did not contain this desired language were required to revise them accordingly.

SEC document requests related to whistleblower topics included:

  1. All compliance or other policies and procedures that were in effect during the Examination Period for the Adviser that pertain to confidentiality/whistleblower topics.
  2. Documents pertaining to communications with officers, directors, employees, or contractors regarding any violations or potential violations of (a) the compliance policies and procedures produced in response to Item X or (b) the Adviser’s Code of Ethics, relating to confidentiality/whistleblower topics.
  3. All documents pertaining to any disciplinary or legal action or potential disciplinary or legal action with respect to any officer, director, employee, or contractor of the Adviser that relates to confidentiality/whistleblower topics.
  4. All amendments to the compliance policies and procedures, including the Code of Ethics, made during the Examination Period pertaining to confidentiality/whistleblower topics.

This summary provides a high-level snap shot of the topics on which the examiners were particularly interested. If the answer to our question “If the SEC showed up today, would you be ready?” makes you less excited about what 2018 may hold for your firm, contact us. We are ICSGroup and we know a thing or two about compliance.