A Compilation Of Enforcement And Non-Enforcement Actions - 31 January 2014

Non-Enforcement Matters

Due Diligence Requirements of Investment Advisers Prior to Recommending Alternative Investments Sub-Advisory Arrangements Under Scrutiny Audit Committee Disclosure Enhancements SEC Guidance on Fixed Income Risk Management Enforcement Matters

2013 Was a Busy Enforcement Year for the SEC SEC Initiates Enforcement Action Against Hedge Fund Adviser Non-Enforcement Matters

Due Diligence Requirements of Investment Advisers Prior to Recommending Alternative Investments

The SEC's Office of Compliance Inspections and Examinations (OCIE) recently issued a Risk Alert for registered investment advisers in connection with due diligence requirements prior to recommending to a client an investment in alternative investments such as hedge funds, real estate funds, private equity funds or funds of funds.

OCIE has from time-to-time issued Risk Alerts when questionable activities, practices or deficiencies by registered investment advisers are detected by the OCIE when it conducts examinations of registered investment advisers.

This Risk Alert lists both the deficiencies or questionable due diligence activities found during the examinations as well as steps that other advisers have taken to perform their due diligence requirements in an acceptable manner.

The deficiencies or questionable due diligence activities with respect to alternative investments noted by the OCIE include: (i) conducting due diligence activities that are different from those described in the adviser's brochure; (ii) failing to conduct adequate due diligence either prior to making a recommendation or during annual reviews of such alternative investments; and (iii) making misleading or incomplete statements about due diligence efforts to its clients.

The due diligence practices observed by the OCIE which appear to be effective include: (i) engaging third parties to validate information provided by managers of alternative investments; (ii) contacting directly the manager and key portfolio managers of the alternative investment to receive information and feedback as to performance and overall management of the investment; and (iii) performing its own quantitative analysis and risk assessment of the alternative investment.

Registered investment advisers are reminded that the OCIE will expect the investment adviser to maintain a file on due diligence activities with respect to each recommended alternative investment conducted both before making the recommendation and periodically during the time the adviser's clients hold the investment.

Sub-Advisory Arrangements Under Scrutiny

There have been a number of mutual fund firms that have been hit with lawsuits in which the plaintiffs allege the firms are charging excessive mutual fund fees in sub-advised funds. The plaintiffs argue that this is evidenced by the fact that the advisors delegate most day-to-day management duties to sub-advisors, but pocket a big portion of advisory fee revenues.

For example, in December 2012, the U.S. District Court for the District of New Jersey declined a motion to dismiss a lawsuit alleging that the fees paid by certain funds advised by Hartford Investment Financial Services, LLC ("Hartford") were excessive under Section 36(b) of the Investment Company Act of 1940. The complaint, Kasilag v. Hartford Investment Financial Services, LLC, Civil No. 11-1083 (D.N.J. Dec. 17, 2012), alleges that Hartford delegated "substantially all" of its investment management duties to sub-advisors, but retained an excessive share of the overall advisory fee thereby resulting in excessive fees being charged to fund shareholders.

Hartford disputed these allegations, noting that...

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