The SEC Office of Compliance Inspections and Examinations issued a Risk Alert on the due diligence processes that investment advisers use when they recommend or place client assets in alternative investments such as hedge funds, private equity funds and funds of funds.
According to OCIE Director Drew Bowden, the SEC issued the Risk Alert because “money continues to flow into alternative investments. We thought it was important to assess advisers’ due diligence process and to promote compliance with existing legal requirements, including the duty to ensure that such investments or recommendations are consistent with client objectives.”
On the plus side, the alert describes the SEC’s observations regarding advisers’ due diligence trends. They found that advisers are: i) seeking more information and data directly from alternative fund managers; ii) using third parties to supplement and validate information about the funds; and iii) performing more quantitative analysis and risk assessment of the investments.
The Risk Alert also points out some areas that the SEC feels advisers should be doing better, including: i) not reviewing their due diligence of alternatives, despite alternatives making up a large portion of assets managed; ii) providing misleading information about the depth of their due diligence; and iii) inconsistent due diligence disclosures.
The SEC publishes Risk Alerts where they believe there is an area that needs adviser focus. The comments in the Risk Alert are not rules or regulations, but they are a good sign of where the SEC will focus their attention during examinations.