SEC presses advisers to do more due diligence on alternatives

Advisers should spend more time vetting private-placement funds and their managers, commission says

Jan 28, 2014 @ 3:49 pm

By Mason Braswell

The Securities and Exchange Commission continues to turn up the heat on financial advisers selling alternative-investment products.

In a Risk Alert released Tuesday, the SEC encouraged investment advisers to be more vigilant in vetting investment products such as hedge funds, private-equity funds and funds of funds.

“Money continues to flow into alternative investments,” Drew Bowden, director of the SEC's Office of Compliance Inspections and Examinations, said in a statement. “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.”

The news follows a statement also made Tuesday by the chief compliance officer at Commonwealth Financial Network that the SEC is homing in on alternatives in its examinations.

It also comes on the heels of other warnings including the SEC's annual exam priorities letter, which said that alternative products such as nontraded real estate investment trusts will once again be a focus this year.

The Risk Alert, which the SEC publishes in order to help firms assess their own compliance efforts, outlines trends that the commission has observed in its exams.

The SEC said that it is seeing a number of efforts by firms to increase their due diligence but also noted deficiencies.

Among the positives, firms are seeking more information directly from alternative managers, using third parties to validate their findings, and performing additional quantitative analysis and risk assessment of alternative investments, including background checks on fund managers.

“The due-diligence process can be more challenging for alternative investments due to the characteristics of private offerings, including the complexity of certain alternative investment strategies,” according to the SEC alert.

Despite the emphasis on alternative investments, some of the firms that the SEC had examined were still lacking.

In fact, some firms weren't reviewing their due-diligence policies around alternatives on an annual basis, even when the investments comprised a large portion of clients' portfolios, according to the SEC alert.

Some firms also had provided misleading information in marketing materials to clients about how much or what kind of due diligence they were doing on alternative products, according to the alert.

The Risk Alert also included a list of warning signs such as a lack of willingness on the part of the fund manager to share information.

Investments that appear to be overly complex, for example, deserve more due diligence or a veto by the adviser, according to the alert.

“Investment advisers are fiduciaries and thus must act in their clients' best interests,” according to the alert. “The [SEC] staff hopes that this overview of examinations concerning the due-diligence practices of advisers will help to support the compliance programs of registrants.”

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