Conflicts Of Interest
By law, RIAs must eliminate or make full and fair disclosure of all the conflicts that might entice them to make decisions in their own best interests rather than the clients’. Those include disclosures about preferred investment opportunities offered to the funds’ top clients—including the advisors’ flagship funds, sub-advised mutual funds, collateralized loan obligation funds and separately managed accounts.
Some private fund advisors allocated securities at different prices or in apparently inequitable amounts among clients without disclosing their allocation process, “thereby causing certain investors to pay more for investments or not to receive their equitable allocation of such investments,” the SEC said.
Some RIAs did not disclose the conflicts they created when their clients invested at different levels of a capital structure—for example, when one client owned debt and another client owned equity in a single portfolio company.
Other private equity RIAs failed to disclose the conflicts they generated when offering some clients preferential liquidity rights. SEC staff found that these advisors entered into agreements (called side letters) with select investors that established special terms, including preferential liquidity terms, but failed to provide adequate disclosure to all investors. “As a result, some investors were unaware of the potential harm that could be caused if the selected investors exercised the special terms granted by the side letters,” the agency said.
Similarly, SEC examiners observed private fund advisors that set up undisclosed side-by-side vehicles or separately managed accounts that invested alongside the RIAs’ flagship funds, but had preferential liquidity terms.
“Failure to disclose these special terms adequately meant that some investors were unaware of the potential harm that could be caused by selected investors redeeming their investments ahead of other investors, particularly in times of market dislocation where there is a greater likelihood of a financial impact,” the SEC said.
In some instances, advisor principals and employees had undisclosed pre-existing ownership interests or other financial interests, such as referral fees or stock options, in the investments, the examiners found.