Misallocation of Fees Subject of Recent SEC Enforcement Actions
Why it's important for investment advisers to be cautious when allocating expenses to a fund without clear disclosure.
The Securities and Exchange Commission recently settled with several private equity firms over misallocated expenses. These cases present valuable lessons for how investment advisers should treat employee- and consultant-related expenses and personal investments by fund principals.
Neuberger Berman. One case involved the SEC’s settlement with Neuberger Berman, a manager of three private equity funds known as the Dyal Funds. Neuberger Berman set up a separate business unit to provide consulting services to the funds. Per the limited partner agreement, the funds would pay for those services. However, the SEC determined that employees within the business unit were not exclusively providing services to the fund—they were also aiding the manager’s investment team—yet the compensation expense to the Dyal Funds wasn’t adjusted to reflect that. The SEC deemed this a misallocation of compensation-related expenses.
Yucaipa. In another case, the SEC settled with private equity firm Yucaipa regarding the firm’s failure to disclose financial conflicts of interest to multiple funds that it advised, as well as misallocation of certain fees and expenses. The SEC determined Yucaipa failed to disclose its practice of charging funds for the cost of in-house employees who assisted with preparing the funds’ tax filings. The SEC said Yucaipa also failed to disclose its practice of charging all expenses from third-party consulting firms in instances where the firms provided services to both the funds and the manager.
The SEC also took issue with a loan made by Yucaipa’s principal to the principal of a consulting firm retained to provide services for the fund. A second consulting firm performed work related to the Yucapipa principal’s personal investments, in addition to providing services for the fund. The consultant was not required to track time spent on the personal investment work, and the entire expense of the services was allocated to the fund.
Takeaways for ACG private equity members
Investment advisers should be cautious in allocating employee-related expenses to a fund absent clear disclosure that the fund may be responsible for certain employee expenses. The SEC is very likely to interpret any ambiguity in LPA language against the adviser and in favor of the fund (and indirectly, fund investors).
Where a consultant is performing services for one or more of the managers, a fund and/or one of more portfolio companies, the manager should ask the consultant to document time generally spent for each “client” and allocate the expenses accordingly, rather than simply allocate the entire expense to a fund.
Where firm principals invest in an entity or business that is receiving income from a fund portfolio company, the conflict of interest should be disclosed and LPA management fee offset provisions should be reviewed to see if any offset is warranted.
