Due diligence duties when an RIA or family office adviser reviews a client's direct startup deal

An adviser's duty on a client's direct deal

A registered investment adviser who gives a client a view on a direct private investment is giving investment advice, and the fiduciary duty applies. The SEC's 2019 interpretation says the adviser must have a reasonable belief that the advice is in the client's best interest, which requires a reasonable investigation so the advice isn't based on materially inaccurate or incomplete information.

This guide is for RIAs, multi-family offices and wealth advisers whose clients bring them startup deals. It's general information about the published regulatory framework and isn't legal advice. Your compliance counsel should decide how it applies to your firm.

What "reasonable investigation" means

The SEC's Commission Interpretation Regarding Standard of Conduct for Investment Advisers (Release IA-5248, June 2019) frames the duty of care in two sentences that matter here. The adviser "must have a reasonable belief that the advice it provides is in the best interest of the client," and that belief "requires that an adviser conduct a reasonable investigation into the investment sufficient not to base its advice on materially inaccurate or incomplete information."

There's no checklist in the interpretation. What counts as reasonable depends on the investment and on what the adviser holds itself out as doing. If the investment fails and the client asks what was checked, a startup deck, a founder call and an informal opinion are hard to defend as an investigation.

What examiners have found

SEC examination staff have looked at how advisers diligence private investments more than once. A January 2022 risk alert on private fund advisers listed a lack of reasonable investigation into underlying investments, inadequate policies on investment due diligence, and advisers that described a diligence process to investors and then didn't follow it.

A 2014 alert on alternative investments found diligence disclosures that deviated from actual practice and marketing that overstated it. What keeps coming up is a gap between what advisers told clients and the process they could actually show. Nobody was faulted for failing to predict an outcome.

A useful benchmark from the broker-dealer rules

FINRA's rules apply to broker-dealers, not RIAs, but they're the most specific public description of a reasonable investigation into a private placement. FINRA Regulatory Notice 23-08 (May 2023) says it should at minimum cover the issuer and its management, the issuer's business prospects, its assets, the claims being made, and the intended use of proceeds.

Notice 10-22 adds that a firm may not rely blindly on the issuer. An adviser doesn't have to follow FINRA's notices. Still, a written review that covers the same ground is easy to explain to a client, an examiner or a court.

What the written record should contain

A defensible record on a client's direct deal has five parts: what the client asked and their stated objectives, what was reviewed and from which sources, the findings with verified facts separated from inference, the conclusion and its conditions, and any conflicts (who paid for the review, whether anyone involved holds or will hold a position).

Don't skip the last one. A review paid for by the company, or by anyone compensated on whether the client invests, is hard to present as independent.

Using outside diligence

Many advisers don't have the in-house skills to investigate a startup's technology, cap table or foreign structure, and don't see enough deals to build them. Outside research can supply the investigation. The advice is still the adviser's, though: read the report, record how it was used, and check the provider's independence.

When to bring in an outside read

Olivent Diligence writes independent research memos on specific startups for advisers and their clients: a written verdict, every claim sourced, fact and inference kept separate, and a disclosure of any Olivent interest in the company. Only the commissioning client or adviser pays for it. It isn't investment advice itself, and it runs $2,500 for a 48-hour Pre-Wire Screen or $8,500 for a Full Diligence in five business days.