On June 29, the Securities and Exchange Commission charged Kohlberg Kravis Roberts & Co. (KKR) with violations of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940, as amended, and Rule 206(4)-7 thereunder for the misallocation of broken deal expenses. The charge addressed KKR’s failure to disclose in its flagship funds’ offering materials that it did not attribute broken deal expenses to co-investor funds.
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In June, the Securities and Exchange Commission’s Division of Investment Management issued a Guidance Update relating to Rule 204A-1 under the Investment Advisers Act of 1940. Rule 204A-1 provides that a registered investment adviser must establish, maintain and enforce a written code of ethics that requires, among other things, its directors, officers and supervised persons who have access to nonpublic information regarding securities transactions of clients or who are involved in making securities recommendations to clients or who have access to such recommendations that are nonpublic (access persons) to report their personal securities holdings and transactions. Subsection (b)(3)(i) of the rule (reporting exception) provides an exception to the reporting requirements when an access person’s securities are held in accounts over which he or she had “no direct or indirect influence or control.”
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The Securities and Exchange Commission’s Rule 206(4)-5 (Pay-to-Play Rule) under the Investment Advisers Act of 1940, as amended, prohibits, among other restrictions, an investment adviser subject to the rule, and its covered associates, from providing or agreeing to provide, directly or indirectly, payment to any third party for a solicitation of advisory business from any government entity on behalf of such adviser, unless such third party is a “regulated person.” A regulated person is defined as (1) an SEC-registered investment adviser, (2) a registered broker or dealer subject to pay-to-play rules adopted by a registered national securities association such as the Financial Industry Regulatory Authority, or (3) a registered municipal advisor that is subject to pay-to-play rules adopted by the Municipal Securities Rulemaking Board (MSRB). In addition, the SECmust by order find that the national securities association and/or MSRB pay-to-play rules: (1) impose substantially equivalent or more stringent restrictions on broker-dealers or municipal advisors respectively than the Pay-to-Play Rule imposes on investment advisers; and (2) are consistent with the objectives of the Pay-to-Play Rule.
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The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) announced that it is launching an initiative, as part of its existing National Exam Program, to examine investment advisers who have never-before been examined and who have been registered for three or more years (the Target Firms). The SEC press release on this initiative stated, “[a]s part of the initiative, OCIE will conduct examinations of a significant percentage of advisers that have not been examined since they registered with the SEC.” A letter directed at the target firms of this new initiative (Initiative Letter) outlines two distinct approaches that the SEC may take with respect to an exam of a Target Firm. The first approach is a “risk-assessment” approach, which is designed to allow OCIE to obtain a better understanding of the Target Firm. An exam under this approach may include a high-level overview of a Target Firm’s overall business activities with particular focus on the Target Firm’s compliance program and other documents essential to assess the representations in the Target Firm’s disclosure documents. The second approach is a “focused review.” Under this approach, the OCIE may conduct a comprehensive, risk-based examination of one or more of the following higher-risk areas of a Target Firm’s business and operations: compliance program, filings/disclosure, marketing, portfolio management and safety of client assets.
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