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Compliance Failures Cost BDC Manager $4 Million in Penalties and $2.6 Billion in Assets

 A BDC manager’s compliance failures led to nearly $4 Million in fines, disgorgement and penalties and the loss of its advisory business.   The SEC charges the firm with misallocating overhead expenses to the registered Business Development Companies it managed and with overvaluing portfolio companies.  The SEC maintains that the registrant used material nonpublic information about BDC portfolio companies to benefit affiliated hedge funds that it managed.  In 2014, the firm had over $2.6 Billion in assets under management but withdrew its adviser registration in 2017 following the SEC enforcement action.  The SEC asserts violations of the compliance rule (206(4)-7) in addition to a laundry list of other securities laws violations.

Failure to implement an effective compliance program has consequences beyond penalties and fines.  The negative impact to a firm’s and its principals’ reputations could ultimately bring down the entire franchise. 

PE Senior Partner Expensed Personal Items to Funds

The SEC commenced enforcement proceedings against the former senior partner of a large private equity firm for charging personal expenses to the funds he advised.  According to the SEC, the senior partner used his corporate credit card for personal expenses that his firm allocated to the funds.  The funds’ governing documents allowed reimbursement for expenses incurred relating to investments and operations including out-of-pocket expenses for business and travel expenses.  Although the conduct occurred over a 3-year period and the company detected unlawful expenses, the senior partner continued to submit false expense reports for which he was reimbursed.  The firm ultimately terminated the senior partner after he reimbursed the funds for over $290,000 in personal expenses.

OUR TAKE: Private equity firms could avoid these problems by only charging management fees (and carry) and end this practice of charging the fund for out-of-pocket expenses.  Any expense reimbursement issues would be the private matter between the firm and its employees.

 

PE Firm Pays $3.4 Million for Broken Deal Expenses Paid Since 2004

A private equity firm agreed to pay over $3.4 Million to settle charges that it failed to allocate broken deal expenses to co-investment funds as far back as 2004.  The private equity funds reimbursed the respondent for broken deal expenses including costs incurred to develop, negotiate, and structure potential transactions that were never consummated.  The SEC faults the firm, which registered in 2012, for failing to disclose that the funds would pay the broken deal expenses allocable to co-investment vehicles utilized by insiders.  The SEC asserts violations of the Advisers Act’s antifraud provision (206(2)) and the compliance rule (206(4)-7) for failing to implement a written compliance policy or procedure governing broken deal expense allocation practices.

OUR TAKE: The SEC reaches all the way back to 2004 to calculate disgorgement even though the firm did not register until 2012.  Private fund firms that registered in 2012 should re-examine their expense allocation practices for years prior to 2012 and consider LP reimbursement before the SEC brings a public enforcement case.

 

Private Equity Firm Charged Overhead and Portfolio Expenses to Fund

The SEC fined and censured a private equity manager and its principals for unlawfully charging the fund both portfolio company expenses and adviser overhead expenses.  The PE manager charged the fund certain consulting expenses provided to a portfolio company without offsetting the management fee as required by the LPA.  The PE manager also charged overhead expenses including employee compensation, rent, and the costs of responding to the SEC examination/enforcement.  The SEC charges that the expenses were not authorized in the fund’s organizational or disclosure documents.  The SEC asserts violations of the Advisers Acts antifraud provisions as well as the compliance rule (206(4)-7) for failing to adopt and implement reasonable policies and procedures.  As part of its remediation, the PE firm agreed to hire a new Chief Compliance Officer.

OUR TAKE: It really is better to build a legitimate compliance infrastructure before the SEC arrives rather than in response to an enforcement action.  An ounce of compliance prevention can avoid the reputation-crushing havoc of an SEC enforcement action.

 

PE Firm Pays Over $1.6 Million for Improper Expense Allocation

A private equity fund has agreed to pay over $1.6 Million in fines and client reimbursement for mis-allocating expenses to its fund.  The SEC charges that the PE firm unlawfully charged legal, hiring, and employee and consulting expenses to the fund.  The SEC interprets the organizational documents as only permitting “normal operating expenses,” including “all routine, recurring expenses incident to” their own operations.  The SEC faults the firm for failing to adopt and implement appropriate compliance procedures including multiple levels of expense review, escalation procedures and oversight.

OUR TAKE: PE firms continue to struggle with expense allocation issues, failing to understand that a fiduciary cannot use a managed fund as a piggy bank to pay firm expenses.  Proper compliance procedures should prevent firms from crossing the fiduciary line.

 

Hedge Fund Manager Used New Funds to Pay Expenses of Old Funds

A hedge fund manager agreed to pay $7.9 Million in disgorgement and a $5 Million fine for using the assets of newer funds to pay the expenses of older funds.  According to the SEC complaint, which was filed in 2010 and related to allocations made between 2005 and 2008, the respondent used assets from more recent funds to pay legal and administrative fees of older funds that could not raise cash because they held illiquid securities.  The SEC claims that the respondent replaced the cash with overvalued illiquid securities.  The SEC continues litigation with respect to charges that the hedge fund manager overvalued securities and made misrepresentations.

OUR TAKE:  The long arm of the law can reach back a long way.   The older funds began to have liquidity problems as far back as 2004, which caused the respondent to raise more assets to pay off old expenses.  And, the litigation continues.