OPERATIONS
"Each adviser, in designing its policies and procedures, should first identify conflicts and other compliance factors creating risk exposure for the firm and its clients in light of the firm's particular operations, and then design policies and procedures that address those risks. "
-See Compliance Programs of Investment Companies and Investment Advisers,
Advisers Act Release No. 2204, Dec 17, 2003
OVERSIGHT
Investment advisers have a fiduciary duty under the Investment Advisers Act to supervise the actions of their employees and monitor the controls of affiliated and unaffiliated service providers, such as sub-advisers, transfer agents, administrators, underwriters, custodians, and marketing agents or solicitors. The firm must document its due diligence of the service provider it has selected, contractually obligate the provider to provide certain services that the adviser has delegated and determine which, if any, services it would prohibit the service provider from outsourcing. The firm should assess the risks of such services, and develop and implement a monitoring program that provides sufficient oversight of risk areas, such as conflicts associated with other services to the firm or its clients, controls related to the provider's services and applicable laws and regulations, including practices related to cybersecurity and business continuity planning, and the service provider's financial condition. An adviser should include in its assessment the adequacy of its service providers' compliance controls in its annual review. An adviser may be found to be in breach of its fiduciary duty if it has failed to provide the necessary oversight of its service providers.
GIFTS AND ENTERTAINMENT
An adviser has a duty to avoid actual conflicts of interest and the perception of impropriety. The adviser should be aware that a gift or charitable contribution could be perceived as an attempt to improperly influence the investment decision by persons in positions of trust and influence. In addition, the adviser and its associates should be aware the recipient's internal policies may prohibit accepting gifts and entertainment, including food, drinks, or events. This is especially likely if the intended recipient is a representative of a governmental organization, a fiduciary in the context of an ERISA plan, or a union official. Advisers of vertically integrated private real estate funds and other investment vehicles with interests overseas may be subject to the Foreign Corruption Practices Act ("FCPA") and the 2011 U.K. Anti-Bribery Act, which prohibit giving "anything of value" to a foreign official, foreign political party or official or candidate for foreign political office. Violators are subject to substantial civil and criminal penalties, up to and including imprisonment. In crafting its gifts and entertainment policy, an adviser should consider thresholds for business meals, sporting events and other entertainment events, pre-clearance procedures, and strict prohibitions for gift giving to certain categories of intended recipients.
FEES AND EXPENSE ALLOCATIONS
A registered investment adviser has a fiduciary obligation to allocate expenses fairly among its clients and disclose its practices to its clients. In the context of private funds, the management fee typically will cover all normal operations of the general partner, including placement agent fees, and fees and expenses borne by the limited partners and the fund. All expense allocations must be disclosed in the fund's governing documents, including broken deal expenses, due diligence monitoring expenses and any management off-sets. Compliance should periodically review these disclosures with any side letter arrangements for potential conflicts of interest. The adviser's written expense allocation policy and procedures should be consistent with the fund, parallel fund and/or co-investment vehicles's governing documents. Advisers must keep appropriate records to demonstrate how expenses where allocated and be prepared to provide the same to the SEC during an examination. Compliance should periodically review the adviser's expense allocations against client disclosures and any expense methodology applied to fund investors must be retroactively shown to be fair. In addition, an adviser should review its legal documents to assess its contractual obligations to investors prior to any decisions regarding "one-off" expenses and document the same. Compliance may periodically review the fund's "shadow" records against the custodian's financial records for any expenses that have been allocated to the fund's investors in contravention of the fund's organizational documents and procedures.
ANTI-MONEY LAUNDERING
Under the proposed rule (see bottom of first page), SEC registered investment advisers will be required to adopt and implement AML programs similar to those currently used by banks and broker-dealers and file suspicious activity reports. Core features of the program include: (1) written policies and procedures, (2) periodic independent testing, (3) designation of an AML officer or other personnel responsible for the program, and (4) ongoing training of appropriate personnel. The proposed rule will also subject advisers to Section 314 of the U.S.A. PATRIOT Act, which permits financial institutions to share information in order to identify and report to the federal government activities that may involve money laundering or terrorist activity. State registered investment advisers or "exempt reporting advisers" would not be subject to these proposed rules. In addition, a Customer Identification Program ("CIP") is not proposed under the rule, but widely anticipated via a joint rule-making effort with the SEC. Once adopted, an adviser firm will have six months in which to comply with the rule's requirements. An adviser can prepare by assessing the scope of its advisory activities, its client base, and the extent to which it may contractually delegate AML activities to a third party. FinCEN has made clear that an adviser that delegates to a third party has oversight of the provider's AML program. Accordingly, if delegated to a third party, the adviser's policies and procedures should address how it plans to oversee and monitor the provider's AML program.