SEC’s examination program issues a risk alert on investment adviser due diligence processes

Abstract

Purpose – To summarize and interpret a Risk Alert titled “Investment Adviser Due Diligence Processes for Selecting Alternative Investments and their Respective Managers,” issued by the USA Securities and Exchange Commission Office of Compliance Inspections and Examinations on January 28, 2014. Design/methodology/approach – Focuses on investment advisers selecting underlying alternative investment managers. Discusses the scope of the Staff’s observations. Describes several due diligence practices observed by the staff, including seeking greater transparency; utilizing third-party information aggregators, administrators, custodians, and auditors; using more quantitative analysis; and extending due diligence process to include operational and liquidity reviews. Lists several observed warning indicators that could lead an advisor to conduct additional due diligence, request the underlying manager to make appropriate changes, or reject or veto an investment. Identifies both positive and negative compliance practices. Findings – The Risk Alert noted several observed risk indicators that could lead an adviser to conduct additional due diligence, request the underlying manager to make appropriate changes, or reject or veto the investment. Advisers can assume that SEC Staff will ask about these risks in future adviser examinations. Originality/value – Practical guidance from an experienced financial services and securities lawyer.