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Lowenstein Sandler LLP

David L. Goret

David L. Goret

Co-chair, Fund Regulatory & Compliance


  • Corporate
  • Debt & Finance
  • Debt Finance
  • Broker-Dealer

WSG Practice Industries


Lowenstein Sandler LLP
New York, U.S.A.


David advises hedge fund and private equity clients on the full panoply of issues facing sophisticated, complex investment managers including various types of transactions (mergers, acquisitions and lending transactions), as well as a broad range of legal, compliance and operating concerns.  Clients value his counsel, referring to David as “fabulous” and a “client relationship superstar” (Chambers USA).

He brings extensive hands-on operating experience and perspective to his legal work in global business as the former General Counsel and Chief Compliance Officer of GSC Group, a large multistrategy asset manager with operations in the U.S. and Europe.  At GSC Group, David oversaw a legal and compliance infrastructure encompassing the formation, operation, and administration of U.S. - and Europe-based private equity funds; U.S. - and UK-based collateralized loan obligations; and primarily U.S.-based hedge funds, structured credit funds, and real estate funds.

David's direct knowledge of the inner workings of a complex investment management firm gives him unique insight into the judgment calls and operating decisions his clients must make on a daily basis.  He has also worked extensively with his clients' portfolio companies on transactional and financing matters.

Throughout his legal career, David has conceptualized, implemented, and administered a broad variety of business relationships, transactions, and legal and compliance operating infrastructures.  He has completed numerous private fund organizations, private placements, mergers, acquisitions, public offerings, securitizations and other corporate finance transactions, with values ranging from $10 million to over $1 billion.  David has also worked extensively with business development companies (BDCs) on regulatory and compliance matters, as well as lending transactions.

A tech enthusiast and general counsel of several startups that went public or were sold early in his career, David also works closely with management of several early stage companies as a trusted legal and business consigliere.

David hosts the Lowenstein Sandler Investment Management Breakfast Series, a series of invitation-only quarterly programs in which senior legal and compliance professionals convene to compare notes on their approaches to key compliance concerns facing leading investment managers.

Bar Admissions

    New York
    New Jersey


University of Michigan Law School (J.D. 1988)
Duke University (B.A. 1985), magna cum laude
Areas of Practice

Broker-Dealer | Corporate | Debt & Finance | Debt Finance | Debt Financing | Derivatives & Structured Products | Fund Formation | Fund Formation & Structuring | Fund Regulatory & Compliance | Hedge Funds | Investment Management | Lending & Financial Services | Mortgage & Structured Finance | Mortgage Banking & Finance | Mortgage Banking and Finance | Real Estate | Securities Offerings | Venture Capital & Tech M&A | Venture Capital, Angel Investing, and M&A

Professional Career

Significant Accomplishments

Represented Exchange Traded Managers Group, L.L.C., a provider of exchange-traded funds, in connection with a debt and equity investment made by Wedbush Securities, Inc., a Los-Angeles based financial services and investment firm.

Represented W2O Group, a New Mountain Capital portfolio company and provider of analytics-driven, digital-first marketing services and communications to the healthcare sector, in connection with the acquisition of all the issued and outstanding units of Symplur, LLC, a healthcare social media analytics company.

Represented W2O Group, a New Mountain Capital portfolio company and provider of analytics-driven, digital-first marketing services and communications to the healthcare sector, in connection with the acquisition of Radius Medical Animation LLC a scientific creative agency that designs interactive and immersive digital media for educational purposes within the healthcare and pharmaceutical industries.

Represented W2O Group, a New Mountain Capital portfolio company and provider of analytics-driven, digital-first marketing services and communications to the healthcare sector, in connection with W2O Group’s acquisition of several businesses, including Arcus Global Media LLC, a medical communications consulting company with expertise in oncology, hematology, transplants and rare diseases and Radius Medical Animation LLC a scientific creative agency that designs interactive and immersive digital media for educational purposes within the healthcare and pharmaceutical industries.

Represented New Mountain Finance Corporation (NYSE: NMFC), a business development company, in connection with the restructuring and acquisition of National HME, Inc., a leading provider of medical equipment solutions to the hospice market.

Represented Lawfinance Limited, formerly JustKapital Limited (ASX: LAW), a leading Australian provider of litigation financing solutions, in connection with the acquisition of National Health Finance, a leading provider of financing solutions for personal injury victims in the U.S.

Represented Revint Solutions, a New Mountain Capital portfolio company and industry leader in revenue recovery and consulting services to the healthcare industry, in connection with the acquisition of each of AcuStream, a revenue assurance specialty company dedicated to the healthcare industry, and CloudMed, a revenue assurance company specializing in the inpatient coding and documentation side of the healthcare revenue cycle.

Represented Topix Pharmaceuticals, a New Mountain Capital portfolio company and independent leader in skincare products, in connection with the acquisitions of Derma E and Clarity Clinical Skin Care, Inc. (dba “ClarityRx”), two rapidly growing California-based natural skincare companies.

Represented AMP Capital, an Australia-based investment manager, in connection with its minority investment in United Capital, a Newport Beach, California-based investment manager.

Represented Medical Specialty Distributors, a New Mountain Capital portfolio company and provider of medical supplies, biomedical services, and technology solutions to the post-acute market, in the acquisition of medical supplies and biomedical service providers, First Choice Medical Holdings, Attentus Medical Sales, and Epic Medical.

Represent numerous fund managers in establishing leading Investment Advisers Act of 1940 compliance programs and in Securities Exchange Commission regulatory examinations.

Represented Presbia PLC (Nasdaq: LENS), a medical device company focused on the development of the presbyopia-correcting Presbia Flexivue Microlens™, in connection with its restructuring and reorganization in Ireland, its initial public offering and subsequent financings in the U.S.

Represented Boulevard Arts, an early stage company that brings the arts to life through virtual, augmented and mixed reality, in connection with its formation, seed and subsequent financings, and its agreements with some of the world’s leading museums and cultural institutions as well as VR, AR and MR suppliers.

Represented internet search company Teoma Technologies in connection with its formation, private financing, and ultimate sale to Ask.com (now part of IAC (Nasdaq: IACI).

Represented software company Mercator Software (NasdaqMCTR) in connection with its sale to Ascential Software Corporation (NasdaqASCL), now part of IBM Corporation (NYSE: IBM).

Represented technology, infrastructure, and services company Icon CMT Corp. (Nasdaq: ICMT) in connection with its private financing transactions, initial public offering, and ultimate merger with Qwest Communications (NYSE: Q), now part of CenturyLink (NYSE: CTL).

Speaking Engagements

The Investment Management Group is hosting its quarterly program designed to assist a select audience of chief legal and compliance officers in addressing important legal and regulatory issues and related operating challenges unique to investment managers. In this series, David Goret and R. Scott Thompson will lead a roundtable discussion of the issues confronted by senior legal and compliance professionals in the administration of their compliance programs. The program, entitled "Not Just Another Day at the Office: Managing Compliance Red Flags and Avoiding Enforcement Actions," will discuss the challenges investment managers face as a result of growing regulatory scrutiny and an expansive regulatory agenda as evidenced by recent enforcement actions.

Our quarterly breakfast programs provide a forum to a select audience of chief legal and compliance officers to discuss important legal and regulatory issues, and related operating challenges, unique to investment managers.

Please join Lowenstein Sandler partners David Goret, Scott Moss, and Benjamin Kozinn as they lead a roundtable discussion in which senior legal and compliance professionals compare notes on their approaches to key compliance concerns facing leading investment managers.

Our breakfast programs provide a forum to a select audience of chief legal and compliance officers to discuss important legal and regulatory issues, and related operating challenges, unique to investment managers.

For more information, email [email protected]

Join Lowenstein partner Marie T. DeFalco, speaker at the 2019 IvyFON Full-Day Seminar, an event dedicated to sharing insights and improving the overall knowledge of the family office and institutional investor class.


  • Marie T. DeFalco, Lowenstein Sandler LLP
  • Andreas Bodmeier, Chicago Atlantic Group
  • Ed Schmults, Calyx Peak Companies
  • Bob Stefanski, eLab Ventures

8 a.m.-4:30 p.m.

Location: Lowenstein Sandler, 1251 Avenue of the Americas, New York, New York 10020

Professional Activities and Experience

  • The Legal 500 - Goret


OCIE Risk Alert: Key Takeaways and Practical Applications for Hedge Fund Managers
Lowenstein Sandler LLP, July 2020

The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) issued a risk alert entitled Observations from Examinations of Investment Advisers Managing Private Funds (the “Alert”). The Alert focused on three principalcategoriesof deficiencies observed by OCIE staff during examinations of registered investment managers that advise private funds...

Additional Articles

On Jan. 7, the U.S. Securities and Exchange Commission’s Office of Compliance Inspections and Examinations released its examination priorities for 2020.[1] This annual publication provides visibility into OCIE’s priorities for the coming year, and an overview of the existing and emerging risks and trends that financial firms[2] should proactively consider and address in their compliance programs.

The exam priorities echo many of the concerns expressed in last year's priorities.[3] Both releases focus on the protection of retail clients, the need for robust information security and cybersecurity policies, the regulation of digital assets, review and implementation of anti-money laundering, or AML, programs, and the protection of critical market infrastructure.

The exam priorities also reference the SEC’s significant rulemaking over this past year, including Regulation Best Interest, or Reg BI, the accompanying client relationship summary, or Form CRS, and various SEC interpretations of the Investment Advisers Act of 1940.

A summary of the exam priorities and how firms may prepare for exams follows.

Protection of Retail Clients

OCIE continues to prioritize the protection of retail clients whom the SEC views as historically vulnerable, such as seniors, teachers and military personnel.

Firms with retail clients or those that market products to retail clients (e.g., mutual funds, exchange-traded funds and municipal securities) should be prepared to demonstrate how they disclose fees, expenses, compensation arrangements and conflicts of interest, as well as how they supervise the outside business activities of associated persons that may

give rise to conflicts of interest. Firms that offer products that are complex or lack transparency should be prepared to demonstrate the disclosure of the characteristics and nuances of such products, which are not likely to be obvious to retail clients.

A new focus for broker-dealers in 2020 will be compliance with Reg BI and Form CRS, which become effective June 30. Reg BI requires broker-dealers to act in their retail clients’ best interests when recommending a security or investment strategy, and prohibits them from putting their interests ahead of their clients’ interests.

Compliance with Reg BI cannot be satisfied through disclosure alone. Firms must implement policies and procedures that ensure security recommendations or investment strategies are, in fact, in their clients’ best interests.

Ahead of the June effective date, broker-dealers are required to demonstrate their progress on the implementation of Reg BI and Form CRS in OCIE exams. Thereafter, exams will assess each firm’s policies and procedures regarding conflict disclosures, the delivery of Form CRS,[4] and the other requirements of Reg BI.

The SEC provided a contact email ([email protected]) for firms with questions regarding the implementation of Reg BI and Form CRS.

Holistic Information Security Policies and Procedures

A successful cyberattack on a financial firm may have consequences that extend beyond any one firm and impact the wider market. Therefore, OCIE has again prioritized information security policies throughout the industry.

Firms should review and test their information security policies and procedures to ensure they meet industry best practices and, if necessary, employ third-party consultants to audit and document the robustness of their information and cybersecurity policies.

These policies and procedures should be reasonably tailored to the firm’s business, particular security risks, and designed to address the following:

  • Proper configuration and monitoring of network storage devices;
  • Governance and risk management policies;
  • Access control policies, especially for firms that offer access online and/or via a mobile application;
  • Data loss prevention policies and procedures;
  • Vendor and network management and oversight, especially for firms that utilize cloud-based storage;
  • Training on cybersecurity concerns;
  • Incident response and resiliency; and
  • Appropriate disposal of retired hardware that may contain client and/or network information.

In the event of a cybersecurity breach, OCIE encourages firms to inform regulators and law enforcement to limit the impact of such breaches on clients or investors and other industry participants.

Review of Firms That Leverage Fintech and Innovative Technologies

OCIE will continue to focus on firms that implement new technologies to drive their business. These technologies include the use of alternative data to make investment decisions; trading automation; the trading, custody and issuance of digital assets; and the provision of investment advice via automated tools or platforms, as done by robo-advisers.

Firms that employ these technologies should be prepared to demonstrate (1) how they use technology to conduct their business and interact with both clients and service providers, and (2) the compliance policies, procedures and controls they have implemented to address risks peculiar to these technologies.

Digital Assets

OCIE notes that digital assets present particular risks for retail clients who do not appreciate the differences between digital assets, such as Bitcoin, and more traditional financial services products.

Due to OCIE’s concerns regarding the general public’s still nascent understanding of digital assets, OCIE will prioritize exams of firms that offer services related to digital assets. These exams will assess, in part, the investment suitability of the digital assets for clients, the firm’s portfolio management and trading practices, the safety and security (i.e., custody) of client funds and assets, the valuation of such assets, and the compliance policies and controls adopted to address risks specific to digital assets.

Such firms should provide fulsome explanations in plain English to clients regarding the basic characteristics of digital assets and the corresponding risks related to the purchase, holding and disposition of these assets.

Electronic Investment Advice

Consistent with the past three years, OCIE has again prioritized exams of robo- or digital advisers. These advisers should anticipate exams soon after registration. As with more conventional advisers, the exam will vary based on the scale of the business and the perceived risk of the advice and types of products offered.

OCIE will review, at a minimum, the adviser’s eligibility for SEC registration, the effectiveness of its compliance and cybersecurity policies and procedures, its marketing practices, and the adequacy of its disclosures to clients, as well as how it addresses conflicts of interest consistent with its fiduciary duty to clients.

In light of OCIE’s focus on new registrants, advisers should ensure that their policies and procedures are in place and operational upon registration.

Review of AML Programs

OCIE will continue to review the AML programs of investment advisers, broker-dealers and investment companies. OCIE exams will focus on the adequacy of policies and procedures, based on the firm’s business and client or investor base, to identify suspicious activity and illegal money-laundering activities.

OCIE’s review of AML policies and procedures will include an assessment of the firm’s customer identification programs, the satisfaction of suspicious activity report filing obligations, the due diligence process for accepting and onboarding clients or investors, compliance with beneficial ownership requirements, and the robustness and timeliness of independent AML program testing.

Given OCIE’s focus on AML, firms should periodically test their AML programs and be prepared to demonstrate that their policies reflect their practices, especially concerning client or investor onboarding, vetting and surveillance.

Additional Market Participant-Specific Focus Areas

Registered Investment Advisers

OCIE examinations of registered investment advisers will continue to focus on Rule 206(4)-7 compliance programs and the extent to which they are reasonably designed and implemented to detect violations of law based on the adviser’s business operations, investment mandates and types of clients/investors.

OCIE expects to scrutinize the accuracy and adequacy of disclosures that offer new, niche or emerging strategies or products such as those currently in vogue with an environmental, social and governance, or ESG, orientation.

According to the exam priorities, OCIE intends to prioritize the examination of investment advisers that are dually registered as, or are affiliated with, broker-dealers, or that have supervised persons who are registered representatives of unaffiliated broker-dealers.

OCIE will also prioritize the examination of investment advisers that contract with third- party asset managers, and will conduct risk-based exams of newly registered and yet-to-be- examined advisers. Investment advisers that have not been recently examined should prepare for an exam that assesses whether their compliance programs and policies have evolved with the investment advisers’ growth and changes in their business.

Investment advisers to private funds that also have an impact on retail clients, such as investment advisers that manage separately managed accounts in addition to private funds, should expect an exam in the near term. Such investment advisers should be prepared to explain how they identify and assess compliance risks, including the controls they have adopted to prevent the misuse of material, nonpublic information; conflicts of interest, such as undisclosed or inadequately disclosed fees and expenses; and the use of affiliates to provide services to clients.

OCIE also intends to prioritize exams of mutual funds, ETFs and their respective investment advisers and boards of directors, given the broad exposure of these products to retail investors. Due to the proliferation of ETFs, OCIE is likely to continue to focus on the evolving industry practices of ETFs, their trustees, service providers and sponsors.


In 2020, broker-dealer exams will focus on compliance with the Customer Protection Rule,[5] the Net Capital Rule[6] and trading and risk management practices. OCIE will also examine how firms address regulatory compliance of trading odd-lot orders (i.e., orders under 100 shares), which often come from retail clients and require special treatment to ensure compliance.

Consistent with the focus on fintech and innovative technologies discussed above, OCIE exams of broker-dealers will also focus on the deployment of trading algorithms and trading automation. Exams will cover how such activities are established and supervised, including the development, testing, implementation, maintenance and modification of the computer programs that support automated trading activities and access controls to the algorithmic trading codes.

A firm’s written supervisory procedures should address the supervision and monitoring of these perceived higher-risk products and activities. As previously mentioned, broker-dealers should also be prepared to demonstrate compliance with Reg BI and Form CRS.


The exam priorities should encourage financial firms to continue to evolve their compliance programs consistent with the evolution of their business in light of the products and services offered, the types of clients/investors served and emerging market risks.

The SEC encourages firms to take a holistic view of their business with an emphasis on client or investor protection. While there has not been substantial movement in the priorities and areas of focus of regulators, the exam priorities support the proposition that compliance is not a static function, but instead a dynamic, living organism intended to evolve and mature with the demands of the business and the introduction of new products and new market risks.

Given the proliferation of digital assets and increased dependence on technology and infrastructure, OCIE continues to emphasize the centrality of thoughtful and robust information security policies and related best practices concerning the protection of sensitive client information.

OCIE will review how technology impacts the investment process, including how investment decisions are conceived and effectuated, and how investments are held for the benefit of clients. Because many of these functions do not represent core competencies of financial firms, OCIE will continue to focus on how these firms perform due diligence and supervise vendors and third-party service providers that perform increasingly mission-critical roles.

Firms leveraging new technologies that affect investment decisions or trading automation should have plain-English disclosures that explain the product features, risks and conflicts and should be able to demonstrate through the use of contemporaneous documentation, the care they take with respect to the safety and security of client assets, adherence to investment mandates and their clients’ best interests. OCIE has expanded its focus on technological innovation employed by firms, and we expect this priority will continue for the foreseeable future.

The exam priorities echo OCIE’s historical focus on industry risks and trends that OCIE believes most impact the U.S. capital markets.

The above analysis of the exam priorities is not exhaustive, and while it lays out the key areas of focus of OCIE’s exams, the scope of any firm exam is determined through a risk- based approach that includes, among other things, analysis of a firm’s history, including prior exams, operations, services and products offered.

As the SEC's Division of Enforcement continues to trumpet its triumphs against bad actors in the industry and its commitment to protecting clients and ensuring that the capital markets operate fairly, financial services firms would be well served to take notice of the exam priorities[7] and devote the necessary time and resources to ensure their compliance programs keep up with the pace of change in the business, in the industry and in the eyes of the regulators.[8]

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.


[1] Available at: https://www.sec.gov/about/offices/ocie/national-examination-program- priorities-2020.pdf.
[2] The 2020 Exam Priorities are addressed to financial firms, including registered investment advisers, registered investment companies, broker-dealers, national securities exchanges, municipal advisers and transfer agents. This article is focused on the 2020 Exam Priorities primarily as they relate to registered investment advisers and broker-dealers.
[3] Available at: https://www.sec.gov/files/OCIE%202019%20Priorities.pdf.
[4] The CRS Release adopted Advisers Act Rule 204-5 and Exchange Act Rule 17a-14, which will require a firm to deliver toretail clients–defined as a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family or household purposes–its current Form CRS. Firms that do not have retail clients to whom such firms would be required to deliver a Form CRS are not required to prepare or file a Form CRS.
[5] The Customer Protection Rule (Rule 15c3-3)essentially requires a broker-dealer that maintains custody of client securities and cash to segregate such securities and cash from the broker-dealer’s proprietary activities. By segregating client securities and cash from a firm’s proprietary business activities, the rule increases the likelihood that client assets will be readily available to be returned to clients if a broker-dealer fails.
[6] The Net Capital Rule (Rule 15c3-1)requires a broker-dealer to maintain more than a dollar of highly liquid assets for each dollar of liabilities. If the broker-dealer fails, this rule helps ensure that the broker-dealer has sufficient liquid assets to pay all liabilities to clients.
[7] Firms should also review the 2019 OCIE releases identified in the 2020 Exam Priorities and build the 2019 releases along with the 2020 Exam Priorities into its annual review and risk assessment. Firms should conduct a mock exam to identify and correct any deficiencies before an actual exam is conducted by the SEC.
[8] See SEC Division of Enforcement 2019 Annual Report at https://www.sec.gov/files/enforcement-annual-report-2019.pdf.

The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) issued a risk alert entitled Observations from Examinations of Investment Advisers Managing Private Funds (the “Alert”).  The Alert focused on three principal categories of deficiencies observed by OCIE staff during examinations of registered investment managers that advise private funds.  The three categories of deficiencies relate to (i) conflicts of interest, (ii) fees and expenses, and (iii) policies and procedures regarding material, non-public information (“MNPI”).  OCIE indicated that the purpose of the Alert is twofold: first, to assist investment managers in reviewing and enhancing compliance programs and second, to assist investors with information regarding deficiencies.

The consistent themes of the Alert are two sides of the same coin – an investment manager’s policies, procedures, and offering documents must reflect what the investment manager actually does or intends to do in practice and an investment manager must closely follow and abide by the terms of its policies, procedures, and offering documents.

While the Alert addressed deficiencies arising in both the hedge fund and private equity fund context, this article focuses on the key takeaways for managers advising hedge funds (as opposed to private equity funds), which typically include liquid, evergreen products, with investments principally in publicly-traded securities, as well as practical suggestions to implement guidance provided by the Alert.

Conflicts of Interest

The Alert identified a number of conflicts of interests that either were not disclosed (at all) or were not disclosed with sufficient detail such that investors could provide informed consent regarding such conflict.

1.  Allocation of Investments

OCIE staff observed that certain investment managers to private funds did not provide adequate disclosure regarding conflicts associated with the allocation of investments among clients, including large private funds, parallel funds, co-investment vehicle, and managed accounts.  The Alert specifically identified instances where positions are allocated preferentially to new clients, higher fee-paying clients, or proprietary accounts and where positions were allocated at different prices without providing disclosure or otherwise in contrast to the allocation process disclosed to investors.

In our experience, these types of conflicts and disclosure issues most commonly arise for hedge fund managers that manage both flagship funds and funds-of-one and/or managed accounts.  Although these clients often employ pari passu trading strategies, there are times when there are exceptions, including when managed accounts include specific investment guidelines or risk parameters that require trades to be allocated differently or at a different price than with respect to the flagship funds.  It is important to disclose to investors both that investments typically will be allocated on a pari passu basis, but that there will be departures from this formula from time to time.  Further, if there may ever be a deviation in the pricing of securities or trades (for instance, where a managed account client requires execution by a particular broker), that fact should be fully disclosed to investors.

2.  Financial Relationships between Investors/Clients and the Investment Manager

OCIE staff observed that certain investment managers failed to provide adequate disclosure regarding economic relationships between themselves and certain investors or clients.  Examples cited include relationships with seed investors or investors providing credit facilities or other financing.

In our experience, these types of conflicts most typically occur with traditional seed investors or other strategic investors providing working capital to the investment manager and its affiliates.  Where these types of investors have notice, consent, or other rights, it is imperative to disclose how those rights might impact other investors and/or influence decisions made by the investment manager.

3.  Preferential Liquidity Rights

OCIE staff observed that, in certain case, investment managers entered into special arrangements with investors, including side letters, offering preferred liquidity and failed to disclose that fact to other investors.  In addition, investment managers failed to disclose instances in which parallel vehicles or managed accounts had preferential liquidity terms under the terms of their organizational documents or advisory contracts.  In each case, investors were unaware of the liquidity terms that could permit others to redeem ahead of them.

In recent years, we have seen a strong aversion in the market to preferred liquidity among investors in the same hedge fund.  Instead, managers now offer multiple share classes with fee and liquidity terms fully disclosed in offering documents provided to all investors.  However, from time to time, hedge fund managers may offer differing liquidity terms to address targeted concerns, such as an investor’s ERISA status or restrictions on the concentration of investments.  In addition, there often remain differences in liquidity terms among specific products such as flagship funds, funds-of-one, and managed accounts.  Investment managers must take care to carefully and fully disclose these differences.  When preparing a firm’s initial offering documents, the disclosure must be sufficiently expansive to contemplate that additional products and the possibility that certain investors may have different liquidity rights.  As investment managers launch new funds and enter into new managed account arrangements, they must revisit the existing disclosure to ensure that it sufficiently describes the actual difference in liquidity terms between the various products.

4.  Private Fund Adviser Interests in Recommended Investments

The Alert identified failures by certain investment managers to disclose personal interests of firm principals in securities recommended to clients, including preexisting ownership interests, referral fees, or stock options.

Often, we see these conflicts arise where a founder sits on the board of directors of an issuer or provides consulting or similar services.  In that case, most managers elect to place the portfolio company on a restricted list and prohibit investment on behalf of its clients.  The important disclosure point here is that the client will not invest in the underlying issuer, even if it otherwise would have been an appropriate investment.  Similarly, because of his or her position with the company, a founder might receive MNPI that bars clients from buying or selling securities of that issuer or another issuer (e.g., customer, supplier, or strategic investor), even where the investment manager might have otherwise made the investment.

In addition, a founder or other firm personnel occasionally will invest personally in a position in which advisory clients also are invested (or keep a preexisting investment in the same position).  The key here is not only to provide sufficient disclosure regarding the personal investment (as the Alert suggests), but also to develop and adhere to guidelines (including heightened levels of internal scrutiny or approval) that mitigate the conflicts of interest that may arise in connection with the personal investment.

5.  Cross Transactions

OCIE staff observed that certain investment managers failed to adequately disclose conflicts relating to cross trades between clients, including when the price at which securities were crossed disadvantaged either the buying or selling client.

In practice, cross transactions are of less concern for traditional hedge fund managers than for managers of illiquid strategies; the positions they trade typically are liquid and a willing buyer usually can be identified in the open market.  Nevertheless, there are investment managers that engage in rebalancing transactions to ensure pari passu treatment of funds and accounts running the same strategy (i.e., following a redemption or subscription).  In those cases, the investment manager must provide disclosure to all applicable clients regrading such rebalancing and the process by which the rebalancing is achieved.  Further, the investment manager should carefully ensure that the rebalancing trade is valued in accordance with the manager’s written valuation policy.  For managers of liquid securities that are marked-to-market, this should be simple and there should be few (if any) instances where deviation from the market price is appropriate.

In addition, investment managers must determine that a cross transaction is not also a principal transaction (based on the ownership stake of the investment manager and its control persons).  Generally, if a firm and its control persons owns twenty-five percent (25%) or less of a private fund or account, a cross trade is not deemed a principal transaction.

Fees and Expenses

The Alert identified a number of deficiencies regarding fees and expenses paid by clients, in particular, those that resulted in clients paying higher fees or expense.

1.  Allocation of Fees and Expenses

OCIE staff observed that certain investment managers failed to appropriately allocate shared expenses (including broken-deal, due diligence, annual meeting, consultant, and insurance costs) between the investment manager and its advisory clients.  Specifically, the allocations did not align with disclosure to clients or with the investment manager’s policies and procedures.  In addition, OCIE noted that, from time to time, investment managers allocated expenses to clients that were not permitted by the governing documents of the relevant fund or account or allocated expenses in excess of contractual limits.

The allocation of expenses is perhaps one of the most frequently discussed topics between hedge fund managers and their counsel.  As the industry trend has moved toward more detailed disclosure of fund expenses, this assessment often has become easier (i.e., is the cost on the list of expenses in the disclosure documents or not)?  However, inevitably there will be new costs and expenses that arise over time or evolve in response to new and changing legal and regulatory requirements.  Further, investment managers must consider and consistently apply a method for prorating shared expenses both among advisory clients and between the management company and advisory clients.  For instance, funds and accounts invested in the same position might share an expense based on the relative size of the respective investments or based on the relative net asset values of the respective funds and accounts (these two measurements may be different if the funds and accounts are not running pari passu strategies).

Most importantly, investment managers must familiarize themselves with, and closely adhere to, the expense terms governing their hedge funds and accounts.  In addition, investment managers must adopt and comply with processes and procedures to monitor when certain costs meet or exceed contractual caps or limits and to ensure that ongoing expenses are appropriately and consistently allocated.

2.  Valuation

The Alert reflects that certain investment managers failed to value client assets in accordance with the manager’s valuation processes or in accordance with disclosure provided to clients (e.g., that the assets would be valued in accordance with GAAP).  OCIE staff observed that, in some instances, the improper valuation resulted in clients paying higher management fees or performance compensation.

As noted above, for traditional hedge fund managers, valuation typically is a relatively straightforward endeavor, given the liquidity of the underlying securities.  However, investment managers must ensure that they comply with the requirement of all offering documents and advisory contracts.  For instance, we note that managed accounts often require that the positions be valued in accordance with the client’s (as opposed to the manager’s) valuation policy.  It is critical that the investment manager (and its administrator) abides by that contractual requirement.  Further, if there are any illiquid positions, the investment manager must carefully follow (or adopt, if this is the manager’s first encounter with illiquid (Level 3) assets) its policies and procedures for valuing these more complex assets, which, by their nature, implicate potential conflicts of interest and greater scrutiny of regulators.  In our experience, seeking input from an independent board of directors or advisory board is often a viable method of cleansing potential conflicts arising from valuing illiquid securities.  In addition, we recommend that investment managers conscientiously and contemporaneously document compliance with their valuation policies and procedures.

Material Non-Public Information and Code of Ethics

The Alert identified several deficiencies with respect to policies and procedures and/or code of ethics, in each case, relating to MNPI.

1.  Policies and Procedures

OCIE staff observed that certain investment managers failed to address risks posed by their employees interactions with insiders of publicly-traded companies, outside expert network firms, and value-added investors.  Specifically, policies and procedures adopted by certain investment managers failed to assess whether MNPI could have been exchanged during interactions.  In addition, investment managers did not address risks relating to access and use of MNPI posed by shared office space or shared systems.

2.  Code of Ethics

OCIE staff also observed that investment managers failed to establish, maintain, and enforce provisions in their code of ethics designed to prevent misuse of MNPI.  For instance, managers failed to enforce trading restrictions and restricted lists.  Managers also failed to establish policies and procedures for adding or removing securities from restricted lists.

Additional code of ethics deficiencies included failure to enforce internal gifts and entertainment policies and failure to require access persons to submit transactions, holdings, and other reporting required by the manager’s compliance manual.  Lastly, the staff indicated that certain investment managers failed to correctly identify access persons under the code of ethics and subject to the manager’s personal trading policies.

The Alert serves as a reminder of the topics that OCIE and its staff have focused upon and emphasized over the past several years – in writings, alerts, and speeches, as well as in examinations, deficiency findings, and enforcement actions.  Investment advisers to hedge funds should keep in mind that not only will OCIE examinations continue to focus on these topics, but institutional investors also will use the Alert to hone their due diligence efforts.  Hedge fund managers and their counsel should use the Alert as a guidepost to proactively review all:

  • policies and procedures to ensure that they reflect how the investment manager actually addresses issues in practice;
  • actual practices to ensure that they adhere to the disclosure in, and contractual obligations of, offering and organizational documents, as well as managed account and other advisory contracts;
  • offering and organizational documents, as well as managed account and other advisory contracts, to ensure that all disclosure accurately reflects the investment manager’s policies and procedures; and
  • offering and organizational documents to ensure that they describe in sufficient detail any conflicts described in the Alert that apply to the investment manager’s business.

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Reprinted with permission from the July 14, 2020, issue of Global Banking & Finance Review. © 2020 GBAF Publications Ltd. All Rights Reserved.

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