26 May 2016

AIC: SEC enforcement proceedings driving changes in the private equity fund industry

Ceresney classified the Division’s recent proceedings into the following interrelated categories.

Undisclosed Fees and Expenses  

The enforcement proceedings in this category involved investment advisers that the SEC maintained failed to disclose certain fee arrangements to their investors, including collecting undisclosed accelerated monitoring fees from portfolio companies and charging undisclosed consulting, legal or other similar expenses to their funds. Ceresney indicated that private equity fund advisers appear to be taking affirmative steps to bring their expense practices in line with disclosures in their organizational and offering documents. In addition, an increased number of investment advisers are revising their Form ADVs to more fully disclose their fee and expense practices. Ceresney also noted an uptick in private equity fund investors seeking more transparency concerning investment advisers’ fee and expense practices. An example of this investor-driven change is the Institutional Limited Partners Association “Fee Transparency Initiative,” which he indicated aims to establish consistent standards for fee and expense reporting and compliance disclosures. Although Ceresney declined to state whether the SEC will bring a case asserting that a particular type of fee, even if adequately disclosed, constitutes a breach of fiduciary duty, he indicated his belief that increased awareness and transparency will lead private equity fund advisers and investors to reach an appropriate balance of the types and allocation of fees borne by investors.

Expense Shifting

The enforcement proceedings in this category involved investment advisers that impermissibly shifted and misallocated expenses, including misallocating broken deal expenses between funds and co-investors, misallocating portfolio company expenses between funds, and misallocating compliance, legal and accounting related expenses between the investment adviser and funds. Ceresney indicated that the SEC’s enforcement proceedings have shined a light on certain inappropriate allocation practices, including the misallocation of fees and expenses as between the adviser and the funds it manages and as among multiple funds with a common adviser, and the need for advisers to be mindful of the fiduciary duties owed to each of their clients.

Undisclosed Conflicts of Interest

The enforcement proceedings in this category involved investment advisers that failed to disclose conflicts of interest to their investors, including affiliated transactions, the investment adviser’s compensation arrangements and the allocation of investment opportunities. Ceresney indicated that while private equity funds typically have a limited partner advisory committee (“LPAC”) consisting of independent investors with the authority to approve or disapprove of conflicts of interest on behalf of the fund, in some instances, private equity fund advisers failed to provide the LPAC members with sufficient disclosures to make such determinations. In each case, the Division looked at whether disclosures to LPAC members provided sufficient specificity to allow them to understand the relevant conflicts of interest and give informed consent. Ceresney indicated that he hopes that these proceedings will lead other investment advisers to proactively change their practices to seek to avoid conflicts of interest with investors and to ensure, at a minimum, that they are in line with their organizational and offering documents.

Ceresney’s speech underscores that the SEC will continue to aggressively pursue impactful cases in the private equity space and that enforcement proceedings have led to significant change in the industry.

Full press release

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