Compliance 101: Risk Alert and Enforcement in the Private Funds Space

Published On October 25, 2020

Just as the pandemic has demanded the public take a flexible approach to their personal and private lives, compliance teams have likewise had to adapt in order to ensure the correct handling of material nonpublic information (MNPI) in the private funds space.

Any enforcement action related to insider trading can be close to fatal for many funds, and certainly for an individual’s career. As such, insider trading is a closely controlled discipline, which has only been tightened further during the shift to work from home, and the ensuing weakening of traditional information barriers by a distributed group of investment professionals, analysts, associates, and portfolio managers.

Two recent developments, both driven by the U.S. Securities and Exchange Commission (SEC), should act as stark warnings to global compliance teams.

In May 2020, the SEC announced that Ares Management LLC, a Los Angeles-based private equity firm and registered investment adviser, had agreed to pay a US$1 million fine because it had failed to implement and enforce policies and procedures reasonably designed to prevent the misuse of MNPI.

The SEC order found that Ares invested $700 million in 2016 in a public company through a loan and equity investment that allowed it to appoint a senior employee to the company’s board. Ares’s compliance policies failed to account for the special circumstances presented by having an employee serve on the board while that employee continued to participate in trading decisions regarding the portfolio company. 

Ares obtained potential MNPI about the company, including through Ares’s representative on the company’s board, relating to changes in senior management, adjustments to the company’s hedging strategy, and decisions with respect to the company’s assets, debt, and interest payments. After receiving this information, Ares purchased more than one million shares of the company’s common stock, which was 17% of the publicly available shares. Ares did not require its compliance staff, prior to approving the trades, to sufficiently inquire and document whether the board representative and members of his Ares team possessed MNPI relating to the portfolio company.

“Investment advisers and private equity firms that place employees on the boards of public companies bear heightened risks that they will obtain MNPI through their representative occupying dual roles,” said Anita B. Bandy, Associate Director in the Division of Enforcement. “It is critical for firms like Ares to have proper policies and procedures in place to address these risks and prevent the misuse of information obtained under these special circumstances.”

The SEC found that Ares violated the compliance policies and procedures requirements of Sections 204A and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder. 

Compliance 101

“The Ares enforcement was Compliance 101. There will always be a conflict of interest when an employee of a private funds company with trading authority is appointed to the board of a public company and that private funds company still invests in the equity,” said Corey McBride, CCO of Analyst Hub.

“That employee should be properly wall crossed over the company’s Chinese Wall. A few action items for the compliance department to then take would involve:”

  • Revoke the employee’s trading authorizations in the equity investment
  • Place the security on the restricted list with the necessary caveats (maybe only a select few individuals in the firm can trade, provided they do not possess MNPI)
  • Ensure the appropriate information barriers are set up so that the employee that sits on the board has no contact with the individuals that are allowed to trade in the name 
  • Ensure the e-communications system is set up properly to detect any misuse of information pertaining to the equity investment and escalate any issues to the highest level of compliance

OCIE’s Risk Alert

In June, the SEC’s Office of Compliance Inspections and Examinations (OCIE) released a Risk Alert that provided an overview of certain compliance issues observed in examinations of registered investment advisers that manage private equity funds or hedge funds. OCIE examines hundreds of private fund advisers each year and is frequently asked about its observations from these examinations as well as common deficiencies and compliance issues. The Risk Alert discussed three general areas of deficiency that OCIE had identified in examinations of private fund advisers: 

  • Conflicts of interest
  • Fees and expenses
  • Policies and procedures relating to MNPI


Section 204A of the Advisers Act (“Section 204A”) requires investment advisers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of MNPI by the adviser or any of its associated persons. Advisers Act Rule 204A-1 (“Code of Ethics Rule”) requires a registered investment adviser to adopt and maintain a code of ethics, which must set forth standards of conduct expected of advisory personnel and address conflicts that arise from personal trading by advisory personnel. 

OCIE staff observed the following deficiencies under Section 204A of the Code of Ethics Rule, in relation to private fund advisers who failed to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of MNPI: 

  • Advisers did not address risks posed by their employees interacting with: insiders of publicly-traded companies; outside consultants arranged by “expert network” firms; or value-added investors (e.g., corporate executives or financial professional investors that have information about investments) in order to assess whether MNPI could have been exchanged. The staff also observed private fund advisers that did not enforce policies and procedures addressing these risks. 
  • Advisers did not address risks posed by their employees who could obtain MNPI through their ability to access office space or systems of the adviser or its affiliates that possessed MNPI.
  • Advisers did not address risks posed by their employees who periodically had access to MNPI about issuers of public securities, for example, in connection with a private investment in public equity. 

Code of Ethics Rule 

OCIE observed private fund advisers that failed to establish, maintain, and enforce provisions in their code of ethics reasonably designed to prevent the misuse of MNPI. 

  • Advisers did not enforce trading restrictions on securities that had been placed on the adviser’s “restricted list”. The staff also observed advisers that had codes of ethics that provided for the use of restricted lists but did not have defined policies and procedures for adding securities to, or removing securities from, such lists. 
  • Advisers that failed to enforce requirements in their code of ethics relating to employees’ receipt of gifts and entertainment from third parties. 
  • Advisers that failed to require access persons to submit transactions and holdings reports in a timely fashion or to submit certain personal securities transactions for preclearance as required by their policies or the Code of Ethics Rule. OCIE also observed advisers that failed to identify correctly certain individuals as “access persons” under their code of ethics for purposes of reviewing personal securities transactions. 


OCIE calling out MNPI, coupled with the hallmark enforcement of Ares, has sent strong signals to private fund compliance practitioners of what to expect in the next exam cycle and what to prepare for. 

This will also give them time to stress-test their current policies and procedures, fine-tune their monitoring systems to positively identify MNPI, and conduct further compliance training to put a big tick in the right box when the regulator comes calling.

For more stories, download the full edition of Radar 9 here.