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In remarks before the IA Watch Annual IA Compliance Best Practices Seminar, Carlo V. di Florio, Director, Office of Compliance Inspections and Examinations, or the OCIE,  of the SEC, offered his views on some matters of import to private equity groups and hedge funds.

Private Equity Groups and Conflicts of Interest

According to Mr. di Florio, the OCIE intends to look at conflicts of interest when examining SEC registered investment advisers that advise private equity funds.  “One area regarding private funds that we are already thinking about concerns how private equity firms and their advisers manage conflicts of interest. The Technical Committee of IOSCO has a report out that describes a number of potential conflicts of interest in the private equity arena, and the Institutional Limited Partners Association has issued a set of Private Equity Principles recently that are designed to address many of these conflicts. When we conduct a risk-focused examination, such as of fund advisers to large private equity funds, we will be looking for conflicts such as these, and for evidence that advisers have been vigilant in identifying such potential conflicts and putting in place effective plans or controls to address them.”

Use of Expert Networks

Mr. di Florio also offered guidance on the use of expert networks.  He stated “One aspect of these cases that I want to highlight is how it underscores the need for advisers to have reasonable policies to prevent insider trading. Information networks when properly designed are just another type of research and hiring them is consistent with what institutional investors should do. I am not suggesting that advisers must avoid using expert networks, but that they should address any increase to their compliance risks that expert networks may pose, and build appropriate controls around information obtained from expert networks, at both the front end and the back end.

Front-end controls could include such things as reviewing the terms of agreements with expert network firms, having adviser staff read and acknowledge the adviser’s insider trading policies, and pre-approving every conversation with an expert. It might mean having, at least occasionally, “chaperoned” conversations — that is, a compliance person is a silent listener to the conversation between the expert and the adviser’s money manager/analyst. The adviser might also want to conduct an evaluation of the controls that are in place at expert networks with which the adviser does business. The adviser might also want to either avoid being involved with an expert who is an employee of a public company, or having extra controls in place.

Back-end controls could include obtaining certifications from adviser employees who use expert networks that they are not trading in on insider information. It could also include testing trading — see what trades the adviser staff makes after the expert conversation; and test at least some of the trades in specific companies against press releases, earnings announcements and 8-k filings. These might also include policies and procedures to monitor personal trading of employees or agents who may have access to material nonpublic information.”

Check frequently for updates on the Dodd-Frank Act and other important securities law matters.

2 Responses to SEC Official States Compliance Examinations of Registered Advisers to Private Equity Funds Will Consider Conflicts of Interest and Offers Guidance on Use of Expert Networks

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