the sec's risk alert and a guide to third party due diligence best practice
DESCRIPTION
The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) recently issued a Risk Alert describing current industry trends and practices in investment advisers’ due diligence on alternative investment vehicles, as well as certain deficiencies observed in several of the advisory firms examined. In response, Cordium is hosting a Webinar which will cover the SEC observations as related to third party due diligence background checks and best practice for advisers that are fiduciaries acting in the best interest of their clients with an open Question and Answer session to follow. Please join the team at Cordium as they discuss some suggested best practice guidelines regarding third party due diligence background checks and the observations highlighted by the SEC in their recently issued Risk Alert. Topics for discussion will include: - Conducting comprehensive background checks of managers, key personnel and entities - Verifying critical service provider relationships - Performing regulatory history checks - Review of offering document materials, information and data directly from the managers of alternative investments - Validating information provided by managers of alternative investments - Formalizing due diligence policies and procedures - Annual reviewsTRANSCRIPT
April 13, 2023CORDIUM POWERPOINT MASTER 1
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THE SEC’s RISK ALERT AND A GUIDE TOTHIRD PARTY DUEDILIGENCE BEST PRACTICE
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Cordium Webinar – April 2nd 2014
Introductions and Format
Speakers
oZabrina T. Barile o Partner, Principal - Cordiumo Manager, Due Diligence Department
oWendy Torreso Assistant Vice President, Due Diligence Department – Cordium
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Please submit any questions throughout the duration of the webinar in the question panel within the GoToWebinar application
Questions
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You can submit your questions using the Questions area in the GoToWebinar console
You can submit your questions using the Questions area in the GoToWebinar console
© Copyright APRIL 2, 2014
Agenda
• Introduction• OCIE Risk Alert• Third-party service providers• Service provider relationships• Independent background checks• Regulatory history review• Legal document review• Terms and issues• Due diligence frameworks• Due diligence deficiencies• Conclusion • Q&A
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Introduction
o The U.S. Securities and Exchange Commission (“SEC”) Office of Compliance Inspections and Examination’s (“OCIE”) recently issued a Risk Alert on “Investment Adviser Due Diligence Processes for Selecting Alternative Investments and their Respective Managers” which highlighted industry trends and deficiencies observed during their examination.
https://www.sec.gov/about/offices/ocie/adviser-due-diligence-alternative-investments.pdf
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Focus of the Examination and Basis for the Risk Alert
o The Risk Alert is based on examinations of SEC-registered investment advisers that manage and/or recommend alternative investments to their clients.
o SEC is placing an increased emphasis on advisers due diligence processes, disclosures and evaluations.
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Utilizing Third Party Service Providers to Supplement Analyses and Validate Information
o Advisers delegated some of their responsibilities to third-party service providers specializing in such services to supplement their due diligence processes.
o Periodic reviews of such providers’ should be conducted to ensure they are adhering to their agreements and responsibilities.
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Independent Verification of Information: Service Provider Relationships
o Advisers independently verifying relationships with key third-party service providers, such as administrators, custodians, and auditors.
o Intensive due diligence should be conducted to ensure that the service provider can provide an adequate level of service to the alternative investment.
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Independent Verification of Information: Service Provider Relationships continued
o Best Practice Guidelines:o Confirm current relationshipso Check for potential conflicts of interesto Confirm that the service provider is independento Research lesser known service providers o Conduct service provider confirmations periodicallyo Check for multiple changes in service providers over a short period of
time
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Independent Verification of Information: Background Checks
o Staff observations revealed that most advisers employed the services of third-party firms to conduct independent comprehensive background checks on the managers and their key personnel.
o A thorough analysis of all findings located should be conducted by those with investigative, analytical, industry, and research experience. Such third-party firms, if utilized, should be able to locate and identify any red flags or derogatory information.
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Independent Verification of Information:Background Checks continued
o Investors should focus on the following areas when conducting an independent background check:o Civil and Criminal Filingso Bankruptcy, Judgments, Liens and UCC Filingso Mortgage and Property Transaction Filingso Regulatory Registrations and Membershipso Regulatory Violations and Disciplinary Issueso Relevant and Adverse News Articleso Anti-Money Laundering (AML) Watch-lists and Politically Exposed
Persons (PEP)
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Independent Verification of Information: Validating Information Provided
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Independent Verification of Information:Regulatory History Review
o Some advisers utilized FINRA BrokerCheck to research the backgrounds of current and former FINRA registered brokerage firms and individual broker-dealers.
o In doing so, advisers can check for:o License or Registration o Disciplinary Actionso Regulatory Actionso Civil or Criminal Litigationo Investor Complaints o Educational and Employment Histories
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Independent Verification of Information:Regulatory History Review continued
o The staff also observed that some advisers reviewed regulatory filings, such as Form ADVs for managers’ histories.
http://www.adviserinfo.sec.gov/IAPD/Content/Search/iapd_Search.aspx
o Form ADV Part 1 - Regulatory or civil litigation within the past ten years.
o Form ADV Part 2 - Adviser’s business practices, fees, conflicts of interest, and disciplinary information.
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Noted Improvements to the Due Diligence Process: Legal Document Reviews
o Most advisers included a review of legal documents as part of their due diligence process in an effort to detect legal document risk.
o At minimum, the following should be reviewed:o Offering Memorandums and Prospectuseso Subscription Documentso Articles of Incorporationo Due Diligence Questionnaires and Marketing Materialo Organizational charts and Biographies of the Principalso Financials (last three years) and Valuation Policies
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Noted Improvements to the Due Diligence Process: A Focus on Terms and Issues
o Gather all disclosed data to identify if there are any:o Inconsistencies in the description of terms among the various
disclosure documentso False or misleading statements made in the marketing materialso Undisclosed potential conflicts of interests or fee arrangemento Terms in accordance with industry standards
o The staff observed that advisers’ due diligence teams tended to focus closely on liquidity issues; likely attributed to managers imposing redemption restrictions on investors during the financial crisis.
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Noted Improvements to the Due Diligence Process: Due Diligence Frameworks in Place
o OCIE found that all advisers examined had either a formal or informal due diligence framework in place.
o Those who adopted detailed written policies and procedures and adequate documentation were more likely to consistently apply such policies and procedures.
o Tailored policies and procedures are essential to internal operations and risk management models.
o Policies should be based on best practices with the goal of satisfying client expectations and regulatory requirements.
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Due Diligence Deficiencies Observed
o The staff observed that with some advisers, the following deficiencies were found:o Due diligence policies and procedures were omitted from annual
reviewso Due diligence practices differed from those disclosed to clientso Misleading information about the scope and depth of due diligence
conducted
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Conclusion
o Develop best practice due diligence guidelines in accord with due diligence industry practices and trends as well as the deficiencies observed in the Risk Alert.
o Periodically audit due diligence practices carried out internally and those delegated to third-party service providers. Make sure they conform with any disclosed policies, procedures and controls.
o Continuously update any due diligence frameworks in place in tandem with new internal policy updates, risks, regulatory updates and industry practices.
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Questions
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You can submit your questions using the Questions area in the GoToWebinar console
You can submit your questions using the Questions area in the GoToWebinar console
© Copyright
Speaker biographies
DUE DILIGENCE RESEARCH & REPORTING 23
Zabrina T. Barile, Principal/Vice PresidentZabrina joined Cordium in August 2004 and manages the Due Diligence Research and Reporting Division. She is in charge of overseeing the research and verifications teams and serves as the primary client contact for Due Diligence clients. Additionally, she focuses on the development, growth and marketing of the due diligence research and reporting services. Zabrina graduated from Fordham University in 1998 with a B.A. and a J.D. from St. John’s University School of Law in 2001.
Wendy Toribio-Torres, Assistant Vice PresidentWendy joined Cordium as a Due Diligence Research intern in August of 2005 during her senior year at New York University. Upon graduation from NYU, Wendy became a full-time DDR employee at Cordium. She was promoted to Senior DDR Associate and most recently to Assistant Vice President. Wendy received a B.A. in Psychology from New York University in 2006 and is currently pursuing her MBA at Kenan-Flagler Business School at the University of North Carolina.
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