SEC Issues Risk Alert Regarding Investment Advisors’ Due Diligence on Alternative Investments

The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) recently issued a Risk Alert on the due diligence processes that investment advisers use when they recommend or place clients’ assets in alternative investments, including private funds such as hedge funds, private equity, venture capital, real estate, and funds of private funds. In so doing, the SEC noted that investment advisors, including pension consultants, increasingly are recommending alternative investments to clients.

“Money continues to flow into alternative investments. We thought it was important to assess advisers’ due diligence processes and to promote compliance with existing legal requirements, including the duty to ensure that such investments or recommendations are consistent with client objectives,” said OCIE Director Drew Bowden.

In its review, the SEC observed several industry trends compared to its prior analysis, such as:

Notwithstanding these trends, the SEC also observed deficiencies in investment advisors’ due diligence processes:

The SEC also observed that “advisors were more likely to have due diligence processes that were consistently applied if they adopted written policies and procedures that were detailed and required adequate documentation.” Further, where advisors delegated certain responsibilities to third-party service providers, periodic review of the third-party service providers was critical to identifying deficiencies in meeting their responsibilities.

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