Private Funds Litigation/Regulatory Year in Review and 2019 Outlook

by Pillsbury Winthrop Shaw Pittman LLP

Pillsbury Winthrop Shaw Pittman LLP

Although the SEC did not bring as many headline enforcement actions against private funds as in years past, it continues to devote substantial resources and attention on investment advisers.


  • The SEC will maintain its scrutiny of disclosures to investors, fee allocations and conflicts of interest.
  • Private funds should continue to remain vigilant, including updating and improving compliance infrastructure and evaluating internal policies and procedures.
  • Cybersecurity remains a high enforcement priority, and advisers should review and update their cyber-related controls and response plans to ensure protection of investors’ information.

Despite being a quieter year overall with respect to high-profile enforcement actions against private funds, in 2018 the U.S. Securities and Exchange Commission (SEC) made clear its intent to maintain its regulatory focus on the industry. The SEC investigated and brought cases against private funds related to the allocation of expenses, valuation of fund assets and unregistered broker-dealers, making clear that compliance obligations remain a priority.

In its first full year of enforcement under Chairman Jay Clayton and Co-Directors of Enforcement Stephanie Avakian and Steven Peiken, the SEC continued its robust enforcement program. When he succeeded former Chair Mary Jo White, a well-known former prosecutor, commentators suggested Mr. Clayton would represent a significant shift from the prosecutorial-minded White—and, combined with President Trump’s anti-regulatory tendencies, would present a lighter touch with respect to the SEC’s enforcement directives. While Clayton’s legacy remains to be seen, the SEC has thus far continued its serious scrutiny of the private funds industry, and we would expect such scrutiny to continue. The SEC’s enforcement actions and public statements have consistently indicated that the commission will not stand idly by with respect to certain types of issues, including improper disclosures to investors, troublesome fee allocations and conflicts of interest. Private funds should continue to remain vigilant and build upon the improvements many already made with respect to compliance, including updating and improving compliance infrastructure and evaluating internal policies and procedures.

Enforcement Highlights – 2018
According to the SEC’s Enforcement Division report on its annual results for fiscal year ending September 30, 2018, despite enduring a hiring freeze since 2016, the SEC had slightly more overall enforcement actions in fiscal 2018, bringing 821 enforcement actions, the second highest total ever. Actions against investment advisers/companies and broker-dealers comprised the second largest category of cases—in fiscal 2018, stand-alone actions against investment advisers/companies totaled 108, a significant uptick from the 82 such actions in fiscal 2017.

With respect to private funds specifically, in 2018, the SEC continued to bring enforcement actions relating to fees and expenses (e.g., charging accelerated monitoring fees on portfolio company exits without adequate disclosure), conflicts of interest (e.g., undisclosed conflicts of interest relating to compensation paid to the firm’s individual partners, advisors and affiliates), and fraud or other misconduct (e.g., old-fashioned defrauding of clients or stealing of client funds to secure financing for investments). While the SEC did not bring as many headline enforcement actions against private funds as in years past, the SEC continues to devote substantial resources and attention on investment advisers and we do not expect the SEC to avert its watchful gaze in 2019.

Overall, the SEC continues to improve its understanding of private fund advisers and firms, building upon its creation of specialized Asset Management Units (created in 2010), the Office of Compliance, Inspections and Examinations (OCIE) (launched in 2012) and its Private Funds Unit. OCIE will continue to focus exams on specific concerns and put private fund advisers on notice by its stated exam priorities, which recently have included allocation of fees and expenses and valuation of fund assets, along with other internal controls and disclosure obligations. Despite predictions of relaxed oversight from the SEC, there have been no reports of an overall let up with respect to the pace of focus of examinations with respect to private funds. The SEC has reminded private fund sponsors that, despite a new administration, the day-to-day activities of the SEC have changed very little and private equity and investment advisers remain an important oversight priority.

Going Forward – Examination & Enforcement Priorities
In the waning days of 2018, OCIE released its 2019 Examination Priorities, previewing key areas where OCIE intends to focus its resources due to perceived heightened risk to investors or the markets. OCIE’s stated 2019 priorities mirrored many of its 2018 priorities, including a focus on portfolio management, conflicts of interests, fees and expenses, digital assets and cybersecurity, and adding an increased emphasis on cryptocurrencies. In recent years, the number of investment advisers examined by OCIE has increased—and OCIE has stated that, in addition to never-before examined advisers, it will continue to prioritize examinations of certain advisers that have not been examined for a number of years, especially if those advisers have substantially grown or changed business models. We urge investment advisers to review OCIE’s entire report for a more in-depth discussion of key areas where OCIE intends to focus in 2019, keeping in mind that examinations can lead to enforcement referrals.

Continued Focus on Cybersecurity
We expect the SEC to continue to focus enforcement resources on cybersecurity matters in 2019. In 2017, the SEC announced the creation of a Cyber Unit with the goal of combating cyber-related threats. The Cyber Unit’s areas of focus include market manipulation schemes (such as those using social media platforms to spread false information), hacking efforts to obtain material nonpublic information, misconduct on the dark web and violations involving distributed ledger technology. In February 2018, the SEC issued additional interpretive guidance regarding cybersecurity disclosures, policies and procedures—emphasizing the importance of public company disclosures regarding cybersecurity matters, along with the need to design and implement appropriate controls and procedures. The SEC also brought several major cyber-related enforcement actions in 2018, including a failure-to-disclose action and a Safeguards Rule/Identify Theft Red Flags Rule action. The Enforcement Division’s 2018 annual report featured its cybersecurity efforts and SEC Chairman Clayton has further emphasized the SEC’s cybersecurity enforcement efforts during remarks. Private funds should regularly review and update their cyber-related controls and response plans, with an emphasis on protecting investors’ information, and similarly maintain controls over their portfolio companies.

Creation of Retail Strategy Task Force
The SEC has made clear that it will continue to prioritize the protection of retail investors. In fiscal 2018, the Enforcement Division created a retail strategy task force to focus on issues such as disclosures concerning fees and expenses and conflicts of interest for managed accounts, market manipulations, and fraud involving unregistered offerings. This increased protection is particularly important as retail investors become a potentially significant part of the future of investments in private funds.

The SEC has highlighted a number of additional areas of enforcement focus, many of which can impact private funds, including:

  • Conflicts of Interest. The SEC remains focused on potential or actual conflicts of interest between private equity advisers and the investors in their funds—including allocations of investments and fees and expenses.
  • Valuation of Illiquid Securities. In 2018, the SEC settled an action against an asset management business alleging that the company improperly valued asset-backed securities held by its funds. This action reinforces the SEC’s interest in the valuations and methodologies behind illiquid securities, including an adviser’s consistent application of valuation policies.
  • Fees and expenses. The SEC will continue to ensure transparency and proper disclosure of investment costs to investors.
  • Secondary transactions. In 2018, in a settled action, the SEC alleged a violation of the antifraud provisions of the Advisers Act where an adviser’s owner and manager withheld material information about a fund’s value in offering to buy out investors’ interests in the fund. This case serves as a warning to owners/managers seeking to engage in secondary transactions—“big boy” language may not be enough where the owners withhold material information.
  • Insider Trading. The SEC continues to pursue insider trading cases using various technological and investigative tools, bringing actions against multiple individuals. Insider trading law continues to evolve, providing all the more reason to steer clear of anything approaching a violation.
  • FCPA: The SEC continues to bring actions for bribery of foreign officials and violations of the statute’s books and records provision, having already attained a number of large settlements in this area. FCPA also remains a top priority for the DOJ, which, along with the SEC, brought several FCPA-related enforcement actions in 2018 involving a variety of industries. Private funds must assess their corruption risks and continually re-evaluate their compliance programs.
  • Pay-to-play. In 2018, the SEC continued to investigate and settle pay-to-play charges concerning contributions to candidates for elected office who had influence over selecting investment advisers for public pension plans. As the 2020 election cycle begins, and our nation becomes increasing enmeshed in perpetual campaign mode, it becomes increasingly important for private funds to re-evaluate their pay-to-play policies and ensure proper implementation.

We expect the Commission to continue or increase its enforcement efforts in FY 2019 as its cyber and other initiatives gain traction. Recent enforcement actions continue to reflect that the SEC appears to consider the lack of harm to limited partners as irrelevant to liability—i.e., the SEC does not typically consider the fact that investors were not harmed to be a complete defense. Private funds should prepare for an active SEC Enforcement Division by focusing on internal controls and fostering a culture of compliance, including increased oversight at the portfolio company level, to ensure that they accurately and completely disclosed information, particularly about conflicts of interests, to their limited partners and other stakeholders.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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