• Due Diligence Requirements of Investment Advisers Prior to Recommending Alternative Investments
  • February 5, 2014 | Authors: Peter D. Fetzer; Terry D. Nelson
  • Law Firms: Foley & Lardner LLP - Milwaukee Office ; Foley & Lardner LLP - Madison Office
  • The SEC’s Office of Compliance Inspections and Examinations (OCIE) recently issued a Risk Alert for registered investment advisers in connection with due diligence requirements prior to recommending to a client an investment in alternative investments such as hedge funds, real estate funds, private equity funds or funds of funds.

    OCIE has from time-to-time issued Risk Alerts when questionable activities, practices or deficiencies by registered investment advisers are detected by the OCIE when it conducts examinations of registered investment advisers.

    This Risk Alert lists both the deficiencies or questionable due diligence activities found during the examinations as well as steps that other advisers have taken to perform their due diligence requirements in an acceptable manner.

    The deficiencies or questionable due diligence activities with respect to alternative investments noted by the OCIE include: (i) conducting due diligence activities that are different from those described in the adviser’s brochure; (ii) failing to conduct adequate due diligence either prior to making a recommendation or during annual reviews of such alternative investments; and (iii) making misleading or incomplete statements about due diligence efforts to its clients.

    The due diligence practices observed by the OCIE which appear to be effective include: (i) engaging third parties to validate information provided by managers of alternative investments; (ii) contacting directly the manager and key portfolio managers of the alternative investment to receive information and feedback as to performance and overall management of the investment; and (iii) performing its own quantitative analysis and risk assessment of the alternative investment.

    Registered investment advisers are reminded that the OCIE will expect the investment adviser to maintain a file on due diligence activities with respect to each recommended alternative investment conducted both before making the recommendation and periodically during the time the adviser’s clients hold the investment.