Sigal Mandelker

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As we have previously observed, private fund advisers face a difficult challenge when SEC guidance (in the form of a speech or a public enforcement order) indicates that certain long-standing practices may be contrary to the securities laws. What does an adviser do when its past practices appear, in hindsight, to have fallen short?

While there are a number of potential “fixes”, including rebating fees, amending the fund documents, amending the Form ADV, and changing prospective practices, doing nothing is a particularly bad strategy. These situations are potential whistleblower events, even if the adviser is not yet aware of any whistleblower.  Advisers must recognize that their personnel might be motivated (economically and otherwise) to bypass internal reporting and report directly to the SEC.  Similarly, investors and others may go directly to the SEC.  When management becomes aware of a potential violation, there is usually a short time window to address the issue before it becomes a bigger problem.  Over the past two months, the SEC has issued over $26 million in whistleblower awards, including a $17 million award. And the SEC is actively pursuing cases against investment advisers relating to improper fees and inadequate disclosures, including a number of cases filed in the past month (see here, here, here, and here).

Letting an issue linger is not an option, because—chances are—the regulators will eventually examine the issue. Below are some key mistakes to avoid when addressing issues relating to the SEC’s whistleblower program.

SECOn May 12, 2016, SEC Director of Enforcement Andrew Ceresney gave a keynote address on Private Equity Enforcement.  Ceresney reiterated the SEC’s view that private equity is a key area for enforcement, and that recent actions show that it is particularly focused on undisclosed fees and expenses and increasing transparency in the industry.  Ceresney also provided guidance on arguments that the SEC staff has typically found unavailing.

Ceresney noted that the unique nature of private equity investments were a concern, asserting that the “investment structure of private equity and the nature of private equity investments can lend themselves to some of the misconduct that we’ve observed.”  However, recent enforcement actions show that problems typically arise when fee and expense allocations are not appropriately managed, giving rise to undisclosed conflicts of interest.  Ceresney further stated that as fiduciaries, private equity advisers are expected to eliminate or disclose such conflicts.