A large BD/IA agreed to pay $2.2 Million in remediation, interest and penalties for failing to recommend the lowest mutual fund share class available to retirement plan customers. Instead of recommending load-waived “A” shares, the respondent recommended other higher-cost share classes that resulted in compensation paid to the BD/IA. The SEC faults the firm for failing to have adequate systems and controls in place to ensure that retirement clients benefitted from available discounts. The SEC also asserts that the BD/IA omitted necessary disclosures about revenue sharing and the impact on overall investment returns. An SEC Enforcement official warned that “these types of actions remains a priority for the Division” as evidenced by its recently-announced Share Class Selection Disclosure Initiative.
OUR TAKE: Firms must implement a system to ensure that eligible clients get the waivers to which they are entitled. Compliance can’t rely on reps self-policing, especially when they receive higher compensation on certain share classes.
The SEC barred and fined a public company Chief Accounting Officer for approving undisclosed expense reimbursements for the company’s CEO. The CEO ultimately repaid the $11.285 worth of perquisites incurred over a 5-year period for personal items such as private aircraft usage, cosmetic surgery, cash for tips, medical expenses, charitable donations, and personal travel expenses. The SEC asserts that the CAO approved the expenses in violation of company policy and without appropriate backup documentation and then failed to disclose the reimbursements in the company proxy statements. The SEC charges the CAO with causing the company to file false reports.
OUR TAKE: We wrote on Friday that the SEC is looking to hold financial executives accountable (see https://cipperman.com/2017/11/17/sec-enforcement-division-targets-financial-executives/). In this case, the SEC doesn’t even allege that the CAO derived any personal benefit by approving his boss’s expenses. Regardless, the SEC holds him accountable for allowing wrongdoing to occur.
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.
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.
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.