A private equity firm, the firm’s CEO, and its CFO/CCO were each censured and fined for overcharging the fund, engaging in improper insider loans, and violating the custody rule. According to the SEC, the CFO/CCO failed to properly allocate management fee offsets for certain deemed contributions, thereby overcharging the fund by about $1.4 Million. The CFO/CCO also arranged improper loans between the fund and the management company and overcharged for organizational expenses. The SEC also charges the firm with failing to deliver audited financial statements within the required 120-day period, in part because one of its auditors withdrew from the engagement. The SEC faults the CEO for failing to properly supervise the CFO/CCO as required by Section 203(e)(6) of the Advisers Act. The SEC alleges violations of the Advisers Act’s antifraud rule (206(4)-8) and the compliance rule (206(4)-7).
Senior leaders will not escape accountability by claiming reliance on subordinates. Also, private equity firms can’t use the funds they manage as their firm piggy banks. They need to implement policies and procedures about the withdrawal and use of funds.
sponsor of a private fund agreed to disgorge its management fees for soliciting
investors without a pre-existing, substantive relationship. The SEC accuses the fund sponsor and its
principal with engaging in a public solicitation through a website and media
interviews. The respondents had filed a
Form D Notice of a private offering. The
alleged public solicitation violated Section 5 of the Securities Act, which
requires a registration statement before engaging in a public offering. During the unlawful offering, the value of the
fund declined 62%, which amounted to over $300,000. The Order notes that the principal had no
prior securities industry experience. The SEC declined to impose further
penalties because of the respondents’ financial condition.
Most securities professionals know that you cannot raise capital in a private offering unless the offeror can document a pre-existing relationship with potential investors. However, as FinTech and the securities markets intersect, the neophytes may not realize that they are tripping over the regulatory wires. This respondent is lucky that the SEC didn’t order full rescission of the offering and the refund of the amount lost.
This case has all the features of an advisory fraud: illiquid assets, conflicts of interest, an affiliated valuation agent, and individuals with questionable backgrounds. It is a cautionary tale for investors, compli-pros, and regulators about how far wrongdoers will go to pursue their illicit intents.
A private equity firm agreed to pay a $400,000 fine and reimburse clients for overcharging fund investors over a 16-year period. According to the SEC, the PE firm did not proportionally allocate broken deal, legal, consulting, insurance, and other expenses to co-investors and employee co-investment funds, thereby overcharging investors in their flagship funds. The SEC also accuses the firm of paying portfolio company consulting fees to co-investors, which resulted in lower fee offsets to the detriment of flagship fund investors. The firm voluntarily agreed to reimburse investors for the expenses and the fees following discovery of the misconduct during a 2016 SEC exam. The SEC charges the firm with failing to implement a reasonable compliance program as well as the Advisers Act’s antifraud rules.
If the firm had implemented a reasonable compliance program, discovered the overcharging, and reimbursed clients before the SEC uncovered the violations during an exam, it may have avoided the public enforcement action and resulting fine. Also, a reasonable compliance program may have avoided the overcharging in the first place. C-suite executives should re-think the cowboy mentality that ignores compliance until the SEC or a client makes them change. It’s much less expensive to change the oil every 5000 miles than to replace the engine if it seizes.
This is low-hanging fruit for the SEC Enforcement Division. When you get sloppy with expense allocations and ignore interlocking financial interests, the SEC can easily make its case that the firm acted negligently by failing to implement a sensible compliance program.
Imposing an unusual fee structure raises a red flag for regulators. Skeptical examiners will spend significant time and resources to understand the fees and ensure they are properly calculated and collected.
The SEC censured and fined a private equity manager for lowballing the price offered to liquidate limited partnership interests. The SEC asserts that the private equity manager, through its principal, offered to purchase remaining limited partnership interests at the December 2014 valuation. The SEC faults the firm for failing to revise the price or fully disclose that it had received financial information indicating that the NAV had increased during the first quarter of 2015. The SEC opines that the offer letter, termed “as an accommodation,” made it appear that the limited partners would receive full value for their interests. The SEC charges violations of Rule 206(4)-8, the Advisers Act’s antifraud rule.
OUR TAKE: We generally advise against principal transactions with clients/investors/LPs. Purchasing private interests directly from a client is so rife with conflicts that no amount of disclosure may be sufficient.
OUR TAKE: Without proper disclosure and consent, a transaction that benefits the fund sponsor or its principals will violate the Advisers Act’s fiduciary duty whether or not the investors suffered any harm. This case also highlights the perils of the CCO dual-hat model whereby a senior executive with a pecuniary interest also serves as the Chief Compliance Officer, thereby avoiding independent scrutiny.
OUR TAKE: We have found the staff to be fairly reasonable if a firm misses the deadline by a few days because of an unusual event such as a hard-to-value security or a change in auditors. When you consistently ignore a regulatory requirement and fail to make changes, the Enforcement Division will treat you as a regulatory recidivist and proceed accordingly.